SEK surges as Riksbank delivers (dovish) rate hike

Summary:

• Riksbank hikes interest rates for the first time since 2011

• The bank sees more rate increases in the next year but CPI and GDP forecasts have been lowered

• USDSEK falls on the Riksbank decision as well as the US dollar widespread weakness

The Swedish central bank decided to hike interest rate for the first time since 2011 despite subdued domestic inflation and ambiguous market expectations. The krona strengthened significantly (it is trading 1.8% higher against the USD at the time of writing) as the rate hike was not expected based on the Bloomberg consensus (based on OIS rates the likelihood had been around 30% hence SEK appreciation should not be surprising).

In spite of the fact that the Riksbank decided to lift interest rates it also did lower inflation projections. Source: Riksbank

Long-awaited rate hike

The key interest rate was lifted to -0.25% from -0.5% and it was basically in line with the bank’s previous statements suggesting that a rate increase would take place either in December or February. Nevertheless, inflation has surprised to the downside during the most of the year except the latest reading for September. Having said that, the central bank still sees higher cost pressures and conditions for inflation to be close the its 2% objective even as it slashed CPI projections at today’s meeting. Basically, the Swedish central bank does not foresee inflation at the target until 2021 and therefore it claims that monetary policy needs to remain expansionary but the need for this has decreased slightly. On top of that, the Riksbank underlines “considerable uncertainty over global economic developments” (Brexit, the trade conflict between the US and China) and this fear was reflected in GDP projections being revised down. In this respect, the key forecast is for 2019 where the central bank sees 1.5% growth compared to 1.9% seen previously. In terms of the rate outlook the bank said that the next hike will probably occur in the second half of 2019, and then two rate hikes a year could happen. During the press conference Governor Ingves said that the bank needs to keep a close eye on the krona. In addition, he said that the bank did not discuss a reinvestment plan this time and it will be a topic at the meeting in April.

Outlook

We think that both SEK and NOK have significant room to gain going forward as both Riksbank and Norges Bank are expected to gradually tighten policy. Moreover, both currencies look highly undervalued based on the REER approach. This along with the fact that the Federal Reserve is likely to slow the pace of rate hikes could lead to better performance of NOK and SEK against the greenback. However, one needs to be cognizant of a commodity risk for the NOK - oil prices. Even as Norway’s reliance on crude oil has diminished in recent years this commodity still accounts for a substantial part of total exports (this decade’s average stands around 55%). To sump up, we see both NOK and SEK to trade higher against the US dollar and these currencies seem to be the best ones to express a bearish view on the buck.