Nordic & Swiss Economics

Riksbank hike wouldn’t do much for embattled krona

Nordic & Swiss Economics Update
Written by Jonas Goltermann

The Riksbank appears determined to raise interest rates into an economic slowdown. While higher policy rates may provide some support for the Swedish krona, we still think that it will continue to depreciate.

  • The Riksbank appears determined to raise interest rates into an economic slowdown. While higher policy rates may provide some support for the Swedish krona, we still think that it will continue to depreciate.
  • To the surprise of most analysts, ourselves included, at its last policy meeting the Swedish central bank reiterated its intention to raise interest rates by 25bp to 0% in December, despite clear evidence of a slowdown in both the domestic Swedish economy and in its key trading partners. This would make the Riksbank the only G10 central bank to raise rates in the second half of 2019. While we struggle to see the rationale for such a move, we now expect the central bank to follow through and raise interest rates.
  • Investors, accustomed to the Riksbank’s habit of over-promising and under-delivering on policy tightening over recent years, appear to price around a 50% chance of a hike in December, much higher than before the announcement. (See Chart 1.) That means that if the Riksbank does hike, the krona will probably appreciate, at least temporarily. But as the market reaction after the announcement last week shows (the krona gained 0.8% against the euro, but gave it back within hours), even tighter policy would not necessarily be enough for the krona to appreciate on a sustained basis.
  • One reason is that this wouldn’t be the first time the Riksbank tried to hike into a downturn before changing tack: it raised interest rates in the summers of 2008 and 2011, only to reverse course quickly after the Swedish economy fell into recession. With economic weakness already evident in poor GDP figures, rising unemployment, and recession-level PMIs, it is easy to see a similar story playing out again. Indeed, our forecast is that the Riksbank will have to reverse course and cut rates in 2020.
  • In addition, even if the central bank didn’t do a U-turn, there would be little chance of further hikes. The Riksbank’s new policy rate forecast indicates that interest rates will not rise again until late 2022. So even if rates do rise in December, investors are unlikely to discount further policy tightening.
  • Another reason is that the relationship between interest rate differentials and the krona exchange rate against the euro has broken down over the past couple of years (as it has for many other exchange rates as well). (See Chart 2.) This suggests that higher interest rates in Sweden may not give much of a boost to the krona.
  • In our view, the global economic backdrop will remain the most important driver of the krona/euro exchange rate. Sweden is one of the most open and trade-dependent economies: its export to GDP ratio is the second highest among the G10 economies. We expect the global economy to slow further and think that the US-China trade war is unlikely to be resolved any time soon, in which case the krona will probably remain under pressure. We forecast the krona/euro exchange rate will breach 11 over the coming months, from 10.73 now.

Chart 1: Swedish Repo Rate Forecasts & Market-Implied Expectations (%)

Chart 2: Krona per Euro Exchange Rate Vs 2-Year Interest Rate Swap Differentials

Sources: Refinitiv, Bloomberg, Capital Economics

Sources: Refinitiv, Bloomberg, Capital Economics


Jonas Goltermann, Senior Markets Economist, +44 20 7808 4069, jonas.goltermann@capitaleconomics.com