- Currency's rally in past month makes it harder to stop easing
- Nation highlights dilemma other central banks will encounter
Sweden’s krona underscores the challenges central banks across the developed world face when contemplating stepping off the treadmill of ever-looser monetary policy.
The krona surged in the past month, reaching the highest on a trade-weighted basis in more than a year, after data from growth to inflation suggested the nation has turned a corner. Some policy makers have even said the economy is now buoyant enough for them to stop adding to the stimulus that’s fueling the recovery.
Yet the stronger exchange rate is holding them back because it has the effect of tightening monetary conditions. Scandinavia’s biggest currency traders say the krona is set for further gains, which would turn into a surge if the Riksbank signaled it was ready to reverse its easing measures.
“It’s going to be very hard for the Riksbank to back out of this policy because when they do, it would have material implications on the exchange rate,” said Carl Hammer, chief currency strategist in Stockholm at SEB AB, the region’s second-biggest foreign-exchange dealer according to Euromoney Institutional Investor Plc’s 2015 market survey.
Hammer sees the krona gaining to 9.1 per euro by June and 8.9 by year-end, from 9.2399 as of 11:10 a.m. in London on Wednesday, after advancing on Tuesday to the strongest level since Jan. 6. If the Riksbank pulled back from easing, the exchange rate would quickly appreciate to about 9, which would force officials to step in to weaken it, he said.
Sweden’s dilemma is something other rich-world central banks will face sooner or later once they’re in a position to consider backing away from the negative interest rates and asset purchases many of them put in place after the financial crisis. It also fuels speculation that the unprecedented stimulus embraced across the globe will stay in place for years -- stoking foreign-exchange volatility.
“The Riksbank knows that the moment they signal more tolerance over FX appreciation, markets are going to move quite aggressively,” said Geoffrey Yu, a strategist at UBS Wealth Management, which oversees $2 trillion and predicts the krona will appreciate more than 2 percent to 9 per euro in 12 months. “There’s never a good way to time anything like this -- clearly, when you pursue such an aggressive strategy, exiting it is going to be difficult.”
Some policy makers reckon that it’s time to try.
When the Riksbank cut its repurchase rate to minus 0.5 percent in February and reiterated a warning that it stands ready to curb the krona’s gains, Deputy Governor Martin Floden opposed intervention and said borrowing costs shouldn’t go much lower. His colleague Cecilia Skingsley told the Svenska Dagbladet newspaper last week she’s willing to tolerate a stronger currency and there’s a high bar to her supporting more easing.
While monetary stimulus tends to debase a currency by boosting the supply, the Riksbank’s measures largely haven’t had that effect because they’ve been a series of tit-for-tat exchanges with the European Central Bank.
Still, for much of last year the measures kept the krona more stable, with the currency ending a two-year slide after officials implemented a negative rate policy in February 2015. It’s only in the past month that the currency’s gains accelerated amid signs of a stronger economy, sending it up 2.5 percent versus the euro and pushing a trade-weighted measure to the highest since December 2014.
A Feb. 29 report showed Sweden’s gross domestic product grew an annual 4.5 percent in the fourth quarter, more than double the European Union’s rate for 2015. And while data Tuesday showed inflation slowed to 0.4 percent in February, it reached a 3 1/2-year high of 0.8 percent the month before. That’s a turnaround from when Sweden suffered the worst deflation among Group of 10 economies.
Inflation will rise in the short-term, according to an financial-industry survey conducted by TNS Sifo Prospera and commissioned by the Riksbank. The poll also predicts Sweden’s central bank to increase its repo rate to minus 0.2 percent in 12 months from the current minus 0.5 percent.
It’s not only forecasters that are becoming more bullish on the krona. While options traders are positioned for declines, they’re less pessimistic on the currency than they’ve been all year.
The premium for contracts to sell the krona versus the euro in three months compared with those to buy narrowed to 0.7 percentage point on Tuesday, the smallest since Dec. 23 and down from as much as 1.2 percentage points in February, according to end-of-day prices compiled by Bloomberg.
Nordea Bank AB, Scandinavia’s biggest lender and its top currency trader, is more confident than most that the Riksbank will at least stand pat on monetary easing, even if a potential jump in the krona means it would struggle to wind back stimulus.
“They’re OK with some krona gains without it being a problem,” said Martin Enlund, a Stockholm-based analyst who sees the currency appreciating to 9.1 per euro in three months before ending the year at 8.9. “They’re ready to rest a bit on their laurels.”