FX Outlook 2018 – Riksbank to unlock Swedish krona potential?

by: Georgette Boele

In this publication: Sweden has inflation above target, strong economic growth momentum and an overheating housing market, but the Riksbank has not been willing to let the krona fly (yet). Recent weaker housing market data could threaten the bull case. The krona should rally strongly if the Riksbank starts hiking official rates in 2018 (in line with its forward guidance), but a sudden loss of economic momentum would call this into question.

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The Swedish krone has disappointed in 2017

The Swedish krona has disappointed in 2017. It has depreciated by more than 3% versus the euro. This is mainly because the Swedish central bank (Riksbank) has remained dovish despite the strong economic momentum and inflation being above its target. In its recent statement the Riksbank said that asset purchases will continue until the end of the year. Inflation is partly caused by temporary factors and it doesn’t like if the krona would appreciate too quickly. It also said that the overheating in the housing market needs to be dealt with by other instruments such as macro prudential measures and tax policy. Moreover, euro strength also played a role in the higher EUR/SEK.

Recently, weaker than expected Swedish housing market data have resulted in fears that the housing market bubble may have burst. Currently, 2y Swedish government bond yields reflect the possibility of more monetary policy easing and this has weighed on the krona. However, the krona has rallied by 9% versus the US dollar which is mainly a reflection of US dollar weakness. The main question is will the Riksbank change monetary policy and will the krona finally rally versus the euro? We try to answer these questions in this report.

The Swedish krone’s fortunes highly depend on the Riksbank

Will the Riksbank hike interest rates in 2018 and will the krona strengthen are the main questions. We think that the Riksbank will start raising rates in the second half of 2018 (in line with its forward guidance). This is because economic growth momentum is positive and inflation is above target.  However, we are less convinced than before because of the recent weakness in the housing market. Also financial markets are less convinced, pricing a total of 50bp rate increases in the coming two years. If an overheating housing market is not a reason for the Riksbank to tighten nor should some housing market weakness be a reason to ease monetary policy. Over recent years, the Riksbank has erred on the dovish side because it wanted to avoid a strong appreciation of the krona versus the euro, because this could dampen inflation. If the Riksbank hikes official rates well before the ECB, this will be the starting shot for a substantial strengthening of the Swedish krona, something it has avoided up to now. If the genie is out of the bottle it will be hard for the Riksbank to put it in again. It is highly likely that if there is more weakness in the housing market or lower economic growth momentum, the Riksbank will probably change its forward guidance and delay the start of the hiking cycle. In short, we think that the Swedish krona will strengthen but it strongly depends on the actions by the Riksbank. The timing for this strengthening could be in 2018 or be delayed to 2019. But if it happens it will probably a substantial move. Our forecasts reflect that the krona appreciation will start in 2018. The Swedish krona remains the most undervalued currency of G10 FX.