Currency Forecast - SEK: Upside Ahead Despite Negative Rates - MAR 2015

Spot 2015 2016
Source: BMI. Last updated: March 4, 2015
SEK/USD, ave 8.29 8.27 8.38
SEK/EUR, ave 9.23 9.10 8.80
Repo Rate, % eop -0.1 -0.1 -0.1

BMI View: The Swedish central bank's surprising decision in February to cut its policy rate into negative territory and launch quantitative easing has led us to downgrade our forecasts for krona appreciation. Nonetheless, we still see modest krona upside versus the euro over a multi-year horizon, supported by a relatively strong growth outlook and a sizeable current account surplus.

Short-Term Outlook (3-6 Months): After testing support at SEK9.75/EUR in late 2014 and early 2015, the krona has appreciated back to trendline resistance at around SEK9.25/EUR. We expect resistance to hold for now, but for it to eventually break in the next three-to-six months in the krona's favour.

Trending Down Versus EUR...For Now
Exchange Rate - SEK/EUR

Long-Term Outlook (6-24 Months): We have lowered our expectations for krona appreciation versus the euro, and now expect an average exchange rate of SEK9.10/EUR in 2015 (it was previously SEK8.90/EUR), and SEK8.80/EUR in 2016 (was SEK8.70/EUR). Our end-2015 projection is SEK9.00/EUR, implying upside from the end-2014 rate of SEK9.44/EUR and the current spot rate of SEK9.23/EUR. The main factor behind this downgrade is the Riksbank's surprise decision to cut its policy rate into negative territory, to -0.1% from 0.0%, and launch a small quantitative easing programme (SEK10bn, or around 0.3% of GDP). Headline inflation has been negative year-on-year for 19 of the 27 months since November 2012, with average inflation at just -0.1% in 2013 and 2014. In 2015 we project an uptick to 0.5%, due mainly to the base effect of oil prices pushing up the year-on-year comparison in H215. Nonetheless, the Riksbank is being extremely cautious lest deflationary expectations become even more entrenched. We have revised down our repo rate forecasts to reflect this shift in monetary policy, with the rate set to end 2015 and 2016 at -0.1% (versus 0.00% and 0.75% in our previous set of projections). Inflation is unlikely to return to the 2.0% target until at least late 2016, according to our projections.

Deflationary Pressure Forces Negative Interest Rate Move
Sweden - Inflation and Policy Rate

The Swedish yield advantage over the eurozone has evaporated. Previously the Riksbank was one of the few central banks in the developed world that had tightened policy in the post-crisis period, raising rates from 0.25% in 2010 to 2.0% in 2011, only to begin relenting shortly thereafter as inflation came consistently below target and the eurozone crisis dragged down Swedish economic activity. Even so, in the four years between Q410 and Q414, Sweden's policy rate was above the European Central Bank (ECB)'s - but no longer, with the ECB's refi rate remaining at 0.05% since September 2014 and Sweden's repo rate dropping to zero the following month. This rate differential in Sweden's favour had been one of the main supports of the krona, but eurozone and Swedish short-to-medium term interest rates are now more or less at par. Alongside this shift, the krona has depreciated, and our lowered interest rate forecast trajectory is the key reason why we have also downgraded our SEK outlook.

Sweden's Yield Advantage Has Evaporated
Sweden Minus Eurozone 2-Year Rate Swap, pp

Beyond the very short term, however, the fundamentals favour the krona over the euro. First, the medium-term Swedish growth outlook is relatively positive; we forecast a 2.4% y-o-y average annual real GDP growth rate in Sweden in 2015-2020 versus 1.4% in the eurozone and 2.1% for developed states on aggregate. This growth will eventually help close the Swedish output gap, with deflationary pressures also set to abate, whereas in the eurozone, the weak growth outlook will keep downside pressure on inflation and the euro. Since the Riksbank's easing decision in February, economic activity data releases have been very strong, and are likely to keep the bank on the sidelines rather than easing policy further, contrary to market expectations which have partially priced in a further rate cut. This relates to the second point, which is that the Riksbank will begin raising rates again in 2017, compared with 2019 for the ECB according to our forecasts. This will help restore the carry differential in Sweden's favour. Third, the Swedish current account surplus will remain among the world's largest, at above 5% of GDP to 2020. The country's strong external position should keep the currency underpinned.

Risks To Outlook

Negative rates represent a bold experiment for the Riksbank. There are many technical reasons why the central bank may be forced to reconsider its strategy, including the reduction in profitability for commercial banks, to the potential hoarding of cash by retail depositors. Any indication that the negative interest rate strategy could be abandoned for such technical reasons would lead to significant krona appreciation.