News & analysis

The Swedish krona is in a strong position to rally against the euro and the US dollar in the coming year as increased expectations of a global economic recovery should aid the procyclical currency. Additionally, Sweden’s economy held up strongly throughout the second wave despite a tightening of lockdown measures in the country in Q4 2020 and Q1 2021, with both economic activity and labour market data confirming the economy’s resilience to the measures. Despite both domestic and external economic conditions favouring a structural SEK rally, the krona faces a headwind from the Riksbank, who now plan to purchase SEK5bn worth of FX each month for the next three years. While the central bank insisted the three-year plan was not aimed at weakening the Swedish krona, instead replacing its need to borrow from the Swedish debt office to finance its FX reserves, the announcement came at a time when the krona was sitting near multi-year highs against the euro. The timing of the announcement suggests the change in reserve systems serves a dual purpose, one of which being a speedbump to the SEK rally.

Monex’s March Forecasts submitted to Reuters

As our previous EURSEK forecasts already envisaged moderate declines over the course of the next 12-months, the announcement by the Riksbank hasn’t resulted in any changes to our SEK forecasts against the euro while triangulations from our EURUSD forecasts have slightly altered USDSEK.

Against the Norwegian krone over the coming year, divergences in the central banks communications will likely see moderate SEK weakness.

The Norges bank recently signalled rate hikes were in view as early as 2022, with risks of policy normalisation even earlier if the speed of vaccine administration accelerates. Meanwhile, in Sweden, the Riksbank have cast a more dovish tone in the last couple of meetings with the rate path remaining unchanged until the end of the forecasting period – Q1 2024.

In our December SEK outlook, we discussed Sweden’s economic reliance on the eurozone recovery. Since then, a sluggish start to the vaccine rollout and vaccine supply issues in the EU mean the economic recovery in the eurozone may kickstart later than initially expected, adding downside risks to the Swedish krona outlook. On the other hand, Pfizer BioNTech, the EU’s main vaccine supplier, stated the delays in delivery will be offset in March as they expect increased supply going forward. On balance, the outlook remains subject to large degrees of uncertainty as the vaccine rollout and Covid-19 data domestically and in trading partners remains key, however the krona stands on a good footing with the economy weathering the recent lockdown measures well.

 

CURRENT ECONOMIC DATA SHOWS SWEDEN’S RESILIENCE TO SECOND WAVE

As was the case for many other countries, Sweden’s second wave was more severe in terms of numbers and hospitalisations. Economic activity was not hit as hard as in the first wave, however, despite Sweden’s relative relaxed approach in Spring 2020. Global industrial production was more limited throughout the first wave as uncertainties about the virus back then caused many countries to lock down fully. In the second wave, the services sector took the brunt of it all while manufacturing output remained elevated. Global trade has therefore largely recovered to pre-crisis levels (chart 1), and Sweden’s small and open economy has benefitted from this. The services sector still struggles as hospitality and transport is down along with tourism and parts of the retail sector, however, the vaccine rollout should narrow the gap between services and other sectors and aid a more even recovery in the coming months.

 

Chart 1: Global merchandise trade largely recovered to pre-crisis levels with Sweden’s open economy reaping the benefits. 

 

Sweden’s Q4 GDP grew 0.5% from the previous quarter, implying that GDP shrank less than 3% over 2020 compared to 3.5% in the US and 6.8% in the eurozone. Sweden’s better economic performance compared to the euro area and US allowed SEK to rally over 7% against both the US dollar and the euro throughout the final quarter of the year (chart 2). The labour market has also shown resilience with the unemployment rate falling back from 9.2% in June to 8.6% in December.

With an eye on the recovery in the coming months, the labour market is expected to improve further as crisis measures for businesses have been extended until June 30th and lockdown measures are expected to ease.

These include short-term lay-offs, deferral of tax payments and reorientation support. A risk remains that once the measures have ended, unemployment will see a spike if the economy has not fully opened yet. Given the pace of vaccination rollout, however, this is a minor risk and the labour market remains well supported by the government, increasing hopes for a sustained economic recovery.

 

Chart 2: Swedish krona rallies over 7% against USD and EUR as second wave is no factor

 

INFLATION SHOCK FROM ENERGY UNLIKELY TO NUDGE THE RIKSBANK TOWARD POLICY CHANGE

Similar to activity, inflation has been elevated in recent months as well. Year-on-year headline inflation accelerated from 0.5% in December to 1.7% in January, just above the consensus of 1.6%. This was largely due to higher energy prices evidenced by core inflation only increasing from 1.2% to 1.8%. Higher food prices also contributed to the headline jump. As for the coming months, annual inflation figures will likely be difficult to interpret due to the distortion by the pandemic, which will cause base effects to push the annual rate of inflation above the Riksbank’s target of 2% in Q2. Inflation is set to rise in the coming months as a gradual reopening should bring a recovery in demand, but even if inflation would stay unchanged for the next three months, May 2020’s reading of 0.4% means the May 2021 reading would still print at 2.1% YoY at current prices. For this reason, markets should look past the distorted YoY figures and focus on the MoM figures until base effects pose less of a risk. We have argued the importance of considering MoM figures in our US inflation analysis in our Feb 15 Week Ahead as well.

A risk to the inflation outlook may be the strengthening Swedish krona, as the Riksbank’s trade-weighted Swedish krona is trading more than 8% higher compared to last year (chart 3) and our forecasts envisage a further increase.

 

Chart 3: Riksbank’s trade-weighted Krona index rose by over 8% over the last year

MONETARY POLICY DIVERGENCE BETWEEN NORGES BANK AND RIKSBANK

The Riksbank acknowledged that despite the expansionary monetary policy stance and flat rate path, it will take until 2023 before inflation is close to the 2% target more permanently. With underlying inflation pressures seen as taking this long to recover, policymakers have reminded markets that rate cuts are in the toolbox, despite Governor Stefan Ingves’ communicated preference for asset purchases over negative interest rates.

For the QE programme, no hints of tapering have been communicated by the central bank either as Ingves said:

it would be more damaging for the Swedish economy to dismantle monetary policy in its present form too early, compared to keeping it intact for somewhat too long

In contrast, The Norges Bank signalled a rate hike as early as 2022, with the first hike being pencilled in at Q2 2022 vs Q4 2022 previously, leading to policy divergence between the two central banks throughout the recovery phase and leaving potential for further upsides in NOKSEK until monetary policy starts to align further into the recovery phase. The policy normalisation path for both countries will depend on the progress of the vaccination programmes. The Riksbank assumes restrictions will be lifted throughout the first half of the year, which seems feasible given Swedish government’s plans to vaccinate its entire population by the end of June. Delivery issues from Pfizer BioNTech and Moderna meant vaccinations in February were delayed, but Swedish Health Minister Lena Hallengren remains confident the adult population will receive a jab within the first half of 2021. Like any other country, a downside risk remains that further supply disruptions will lead to delays in the vaccination rollout, however Sweden is ready to scale up its vaccination programme as soon as it gets access to more doses, according to SKR. On balance, the risks attached to our SEK views are skewed towards additional SEK strength against USD and modest gains against EUR, while we expect SEK to weaken against the Norwegian krone.

 

 Author: Ima Sammani, FX Market Analyst

 

 

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