- The Riksbank continues to pour cold water on expectations of tighter monetary policy and a higher krona…
- …while the economy is strong,
- … inflation is at target and inflation pressures are building
- The krona is the most undervalued currency in G10 FX
- We expect it to rise, especially next year…
- …and we look for opportunities to position well in advance
Since the start of this year EUR/SEK has barely moved; it has risen by only 0.6%. The lack of movement is mainly the result of the Riksbank’s behaviour to pour cold water on any expectation that monetary policy might be changed and/or of a higher Swedish krona. In fact, at its 26 April meeting it decided to continue purchasing government bonds during the second half of 2017. It also communicated that the repo rate will be held at -0.5% and is not expected to be raised until mid-2018. On Thursday, inflation numbers were released above expectations and this supported the krona somewhat. Will the behaviour of the central bank and the krona change in the near-term?
Is the economy ready for a stronger krona?
We think that the Swedish economy will be able to withstand a stronger krona. First, the economy is growing at a healthy rate of 2.3% yoy (Q4 2016). Economic growth is broad-based meaning that private consumption, government consumption, fixed investment and net-exports all contributed to growth. Second, service inflation is running at 2.4% yoy (April) while core is at 2.0% and headline inflation close to 2.0% (all at or above the 2% inflation target). Third, inflationary pressures in the economy are building, as can be seen in the pick-up in hourly earnings. Last but not least, household debt as a percentage of disposable income has been rising sharply from 166% in 2013 to close to 195% in 2019 according to the forecasts of Swedish authorities. So the state of the economy would favour the exit from the very loose monetary policy stance in our view.
Why is the Riksbank more cautious?
Given the above, it seems that the Riksbank keeps on searching for arguments to continue its loose monetary policy. Probably because it does not want to be the first central bank in Europe to pull the trigger by announcing less accommodative monetary policy ahead. There could be several reasons for this. For a start, the Riksbank could be concerned about the structural developments in the trade balance. The trade balance has deteriorated since 2006 from a substantial surplus in 2006 (8% of GDP) to a small deficit in March 2017. If the krona were to strengthen in a dramatic fashion, the trade balance would deteriorate even further (cheaper imports and more expensive exports). Therefore, it is likely that the Riksbank would first like to observe how the ECB handles the situation of exiting from loose monetary policy.
Second, the Riksbank has mentioned that it is concerned that Brexit and political uncertainty in the eurozone (German and Italian elections) would have a negative effect on Sweden as it is a very open economy. Consequently, it waits until there is more clarity about these events before changing its monetary policy bias.
What does this mean for the krona?
The krona is the most undervalued currency in G10 FX according to Purchasing Power Parity (EUR/SEK of 7.9). The cyclical state of the economy is strong and this would support an exit from loose monetary policy and a stronger krona. It is likely that expectations of tighter monetary policy will come earlier than now is anticipated by financial markets (Q2 2018). We have a strong conviction that the krona will strengthen substantially between now and the end of 2018. We think that any weakening of the krona beyond 9.8 versus the euro is an opportunity to position for strength in 2018.