FX Watch – Scandi FX Strategy

by: Georgette Boele

  • The Norwegian krone and Swedish krona have outperformed the euro so far this year…
  • …reflecting a weak euro and stronger-than-expected domestic economies
  • We expect  weakness in the Norwegian krone and Swedish krona in there months ahead
  • …because of more monetary policy easing
  • The Danish krone is expected to stay in the currency regime

Scandinavian currencies do well so far this year

After the aggressive sell-off in 2014, the Norwegian krone and the Swedish krona outperformed the euro so far this year, but they have underperformed the US dollar. Why is this? The euro has been weak this year whereas the economies of Norway and Sweden were not as weak as feared. Furthermore, the Danish krona has remained within the tight range. The focus of Scandinavian central banks has not changed; they have continued their monetary policy easing. However, their motivations have differed. The Swedish central bank or Riksbank has been mainly focused on low inflation or deflation. In contrast, the Norges Bank has been sensitive about domestic economic growth despite inflation being close to target.

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Furthermore, Danish central bank is mainly focused on keeping the EUR/DKK range relatively stable and within the currency regime. It has been heavily intervening to stop speculation that the currency regime would be dropped. So far its actions have proven to be a success.

Fighting deflation remains a priority for the Riksbank

Inflation has been too low in Sweden. The minutes of the April meeting show that a more expansionary monetary policy is required to ensure that inflation rises towards the target sufficiently quickly. At that meeting, the board decided to purchase government bonds for a further 40-50 bn. In addition, the repo-rate path was lowered significantly compared to the decision in February.

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Recently, inflation data surprised on the upside. Headline CPI yoy has moved into positive territory again (0.1%). As a result, the probability of further monetary easing by the Riksbank this year has decreased. However, we judge it is too early to call the end of deflation. Since 2013, Swedish headline inflation has moved in a -0.65% to 0.25% range and it frequently moved above zero. We expect further monetary policy easing in the form of more quantitative easing, a lower repo-rate path, further rate cuts or a combination of these. In case the krona were to strengthen considerably, the Riksbank would see this as a threat to its inflation target. It is therefore likely that it would step up monetary policy easing in such an occasion. It seems to have a preference for a weaker krona, because this would help in reaching its inflation target. The Riksbank will decide on monetary policy on 2 July and more easing is likely. This should weigh on the krona going forward.

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Growth the priority for the Norges Bank

On 18 June, the Norges Bank cut interest rates by 25bp to 1.0%. It stated that developments in the Norwegian economy have been weaker than expected and that the economic outlook has deteriorated. Therefore, it lowered the official interest rate. This decision was in line with market consensus. It signaled that the key policy rate may be reduced further in the course of the autumn. Therefore, the Norwegian krone slipped after the result. The Norges Bank also stated that the krone depreciation in 2014 will underpin consumer price inflation in the coming period. Currently CPI is close to target (2.5%). While further ahead, lower wage growth and fading effects of the weaker krone will pull down on inflation according to the Norges Bank.

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Looking ahead, our energy analyst expects oil prices to weaken in the coming months because of supply overhang and lower risk-premium. This will weigh on the Norwegian economy and on the krone. The krone has a tendency to weaken when oil prices fall (see graph below). Therefore, it is likely that the krone will also weaken. The negative effect of lower oil prices on the economy will probably trigger more monetary policy easing as was already signaled by the central bank. However, the Norges Bank probably wants to avoid a sharp weakening of the krone, because pass-through effects on inflation. This may limit the room to manoeuvre for the Norges Bank. But growth has a higher priority than inflation at the moment.

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Further down the road, we expect the Norwegian krone to recover if oil prices rise again later this year and the economic growth picks up.

Danmarks Nationalbank successfully stabilised EUR/DKK

In the weeks following the Swiss National Bank’s decision to abolish the floor in EUR/CHF on 15 January, there was increased demand for the Danish krone. This was because of market expectation that the currency regime in Denmark would be ended. To counter this speculation, the Danmarks Nationalbank has heavily intervened in currency markets (selling the krone) and has lowered interest rates. In addition, the Ministry of Finance decided (at the recommendation of the Danmarks Nationalbank) to suspend issuance of Danish government bonds as from 30 January. These actions have resulted in more stability in EUR/DKK.

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Policy of permanent anchoring…

Since the 1980s Denmark has had its exchange rate anchored to the Deutschmark/euro, as it judged that the resulting stability would have positive effects on inflation and growth. The eurozone is its largest trading partner. For example 38% of its exports are destined to the eurozone. As Denmark is part of ERM2 (see box) the ECB is also committed to protecting the peg. The main objective for Danmarks Nationalbank is to ensure stable prices, i.e. low inflation (below but close to 2%, similar to the target of the ECB). This is achieved through the monetary and exchange rate policy.  As the policy of Danmarks Nationalbank is aimed at keeping the krone stable against the euro; it usually changes its interest rates in sync with monetary policy rates of the ECB. To avoid the strengthening of the krone it will probably intervene again in currency markets. It judges that it has scope for unlimited intervention, because there is no upper limit to the size of foreign exchange reserves. In addition, it could cut interest rates below that of the ECB because of the absence of QE in Denmark (apart from FX intervention) and inflation being far away from its target.

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