Rate hike from the Riksbank

illustration: DNB markets dealingroom

(05.07.2011) Yesterday was without the large highlights and can be characterized as quiet. Today the Riksbank meets, and both we and consensus expect a rate hike by 25 basis points to 2.00 per cent.

By Maren Romstad, Analyst at DNB Markets

With no important key figures and closed markets in the USA due to Independence Day yesterday was without any major highlights. In Europe, Standard & Poor’s curbed the recent risk rally after warning that a debt rollover plan for Greece would place the country in selective default.

Despite closed markets the US dollar has strengthened since our last report. However, most of the movement came in Asian trade. Asian stock markets traded more or less flat, but Chinese shares fell on a report about an imminent interest rate hike and further signs of a slowdown.

Today’s agenda is neither packed with highlights, with the Riksbank’s monetary policy meeting as the exception. Both we and consensus expect the Swedish central bank to hike the repo rate by 25 basis points to 2.00 per cent. This will be in line with the central bank’s own rate path. Furthermore, the economic development has been more or less as outlined by the Riksbank in April. Inflation figures have been as expected. On the other hand, improvements in the labour market have not been as strong the last few months than earlier this year and production figures are showing signs of a slowdown. International interest rates have been lower than projected by the central bank and the Swedish krona has depreciated. These factors imply that the rate path may be lowered somewhat.
Sine their last monetary policy meeting in April the Swedish krona has weakened, after being one of the best performers in the FX market since early 2009. A relatively strong Swedish recovery, monetary policy hikes from the Riksbank and a normalization of risk appetite have for a long time befitted the krona. Since the though in the aftermath of the financial crisis the trade weighted krone has appreciated by nearly 30 per cent. But in recent months this trend has reversed, and SEK has weakened against the euro, NOK and on a trade weighted basis.

The depreciation can largely be explained by fundamental factors, and the same factors contributing to the strong appreciation earlier. One factor that has been an important driver for all currencies recently is interest rate differentials. Both against the euro zone and Norway, Swedish rates have had a relatively weak performance. On the other hand, the rate differential against Japan, UK and the USA have increased and, hence, also been supportive for SEK against the same currencies.

Much of the strengthening of SEK since 2009 was rooted in one of the strongest recoveries worldwide. After being hit hard by the global recession, the recovery accelerated during last year. In the fall Sweden was one of the few industrialized countries back on pre-crisis GDP levels. Now, however, as for a large part of the world, there are signs of a slowdown. This can be illustrated by looking at different confidence indicators, such as the NIER and PMI indices. Previously, these indices have been good indications of the economic activity in Sweden. The indicators are still at high levels, but are steadily abating.
In addition to interest rate and growth prospects there are several other important drivers for the Swedish currency. Especially important are perhaps different indicators of risk appetite and market turmoil, since SEK is a relatively small and peripheral currency. General market turmoil and a weak tendency in stock markets have probably contributed to the weakening of the Swedish krona.

Surprisingly this has not affected the Norwegian currency in a negative manner, which could imply that interest rate differentials are a more important driver today. If this is the case, our forecasts suggest that SEK could remain stable against the euro short term. Longer term we expect the rate hikes from ECB to come to a halt, which should support SEK. In six to twelve months we forecast EURSEK to trade around 8.70.