One of the major impacts of Draghi’s very strong December easing hints last week (see here) is to pass the easing baton back to other previously-dovish central banks (in addition to capping nascent EUR appreciation, being bullish for EA government bonds with likely peripheral spread narrowing and potentially supporting the recent EM FX rebound). Here ECB-satellite Central Banks like the SNB and the Riksbank seem particularly challenged, although the BoJ’s Friday decision could also be impacted, fearing that failure to match the ECB moves will eventuate currency appreciations. Importantly, both SNB and Riksbank have previously been sufficiently concerned about forestalling currency strength to act aggressively.
SNB Vice President Fritz Zurbruegg yesterday hinted that the SNB would have the ECB actions in its sights over the coming months. But the SNB don’t meet again until December (absent an emergency meeting). But tomorrow’s Riksbank meeting is definitely in play. [As an aside, there’s virtually no chance of the Fed acting tomorrow. But there’s a good chance of the statement being updated to be more sanguine about China given apparently data bottoming (see my Back to the Future post) and Friday’s PBOC rate cut and RRR reductions, as they’ll likely want to keep December in play but importantly without undermining the nascent risk appetite recovery.]
At the least Riksbank Governor Ingves will be very dovish tomorrow, jawboning SEK and remaining in the central bankers club highlighting international deflationary forces (notwithstanding Chinese data reportedly bottoming out and Friday’s PBOC rate cut are RRR reductions). But there’s also a good chance of QE being extended (probably into 2016 Q1, although that’s still before ECB QE is die to end, even before the 6-12 month extension I anticipate) and a further rate cut. On the latter the Riksbank’s September repo path implied rates of -0.41% in Q1 2016, versus the current -0.35% policy rate, so reducing the latter to -0.45% wouldn’t be a massive step. And the ECB experience suggests that rate cuts are the most effective at offsetting nascent FX strength, likely because they more directly impact the front end of the yield curve and hence carry trade incentives. But several motivations for Riksbank caution, including uncertainty about what ECB will do in December and solid-looking Swedish domestic fundamentals, seem to reduce the chances of a further rate cut tomorrow.
I wouldn’t completely rule out a 10bp rate cut – and it would be most negative for SEK of the various scenarios (with EURSEK likely to rise back fall back towards August’s 9.60-ish levels, unwinding the fall since then). Conversely, it would be a major surprise if the Riksbank didn’t at least mirror the ECB in again strongly hinting at future rate cuts (lowering the previous bar): failure to do so would likely see SEK rebound reasonably sharply (with EURSEK potentially falling towards the mid-June low around 9.20). In the middle, a Riksbank QE extension would likely be broadly neutral for SEK, given that it appears to have been largely discounted (hence rationalising the limited 0.6% EURSEK fall and 2% USDSEK rise since Draghi spoke last week).
The background is that Riksbank commentary was notably more upbeat in September: “Economic activity in Sweden is strengthening and inflation is showing a clear upward trend”. Moreover, subsequent inflation outturns have been broadly in line with the Riksbank’s forecasts. That said, the Riskbank’s inflation forecasts look pretty optimistic (even if lowered by 0.2pp in 2015 and 2016), with CPIF forecast to rise from 0.9% in 2015 (latest of 1.0%) to 2.0% in 2016 and 2.2% in 2017. The downside inflation risks were also scaled back.
But an important prerequisite of that 1pp CPIF rise over the next year, given the global deflationary environment, seems to be strong wage settlements in the key early-2016 negotiations round. So the Riksbank will want recent subdued inflation expectations, in both the latest Propsera survey and inflation breakevens, to have reversed in advance of that. Riksbank easing would both provide a push in that direction and reduce the risk of SEK strength pulling down on inflation expectations.
Indeed, despite the overall positive tone in September Ingves made clear that the Riskbank still had high level of preparedness to take further action if needed. He referenced a weaker international outlook, looser foreign monetary policy and SEK strength as motivators of further action. Given that all three have subsequently transpired Ingves can provide a coherent narrative for precautionary action now. Moreover, in early October both Skingsley and Floden expressed concerns about SEK strength, reiterating their willingness to act. Floden argued that SEK gains didn’t reflect positive news on Swedish inflation, being instead more likely triggered by non-Swedish developments. He further argued that “If the krona strengthens without other pieces of information that lead to the inflation pressure being revised upwards, that will place a downward pressure on our inflation forecast, obviously,” And the 0.6% fall in EURSEK since Draghi’s dovish performance last week, will likely worry the Riksbank as a taste of further SEK strength should they stand pat tomorrow.
As mentioned above, several factors suggest some Riksbank caution on pre-emptive easing tomorrow, with the policy stakes rising, probably especially on further rate cuts (so it’s less of a done deal than some market comments imply). In particular:
• Residual uncertainty about precisely what the ECB will do in December: Riksbank might not want to pre-empt ECB rate cuts. My view is that the ECB will cut the deposit rate by 10-20bp as well as extending QE by 6-12 months (see here and here) but Riksbank may be more circumspect.
• Continued strong domestic (e.g.today’s upside news in NIER’s influential Economic Tendency Survey featured rises in both consumer and (particularly) manufacturing confidence) potentially causes the Riksbank to start asking whether there’s sufficient momentum to handle (some) SEK appreciation (probably not yet with inflation expectations subdued);
• Concerns that Riksbank will eventually struggle to match ECB dovishness – Riksbank QE seems more likely to face supply constraints – so could eventually decide to “do an SNB” and stop throwing good money after bad (again not yet).
• Previous concerns about the housing market boom and rising debt levels may eventually resurface (although they remain sensitive to criticisms that this caused a previous policy error and Floden’s 13 October speech describes interest rates as a “blunt tool” to address debt worries).
• Worries that they could start being more explicitly labelled currency manipulators, perpetuating currency wars (so far their small size and motivating easing by weak inflation prospects have meant that they’re “got away with it” thus far, but the “duck test” seems to be increasingly met given strengthening domestic fundamentals).