Negative Rates Fail to Dislodge Krona Strength

Despite the extreme monetary policy measures undertaken by the Swedish Riksbank over the last few years in an effort to insulate the economy and prevent deflation, the Krona continues to appreciate modestly versus the US dollar, causing anxiety among policymakers. As the economy continues to recover after several years of negative shocks, newfound strength in the Krona could derail progress on growth and inflation, two areas of critical importance for Central Bank officials.While the prospect of higher interest rates in the US might be enough to dissipate recent weakness in the USDSEK pair, forward-looking uncertainty and slowing economic activity might force further accommodation or an intervention from the Swedes as they work to fend off Krona appreciation.

Fortune Reversal

After gross domestic product expansion printed at the highest rate in five years back in the fourth quarter of 2015, first quarter growth momentum has tapered to 0.50%, marking the slowest pace in six quarters.While negative interest rates have helped to keep inflation in positive territory, with the latest headline consumer price figure recorded at 0.60%, it has penalized savers and created risks in the housing sector.Construction is one of the key drivers of recent blockbuster growth which has placed Sweden it among the most competitive economies in Europe according to recent findings.However, while the refugee influx has kept construction companies operating at full capacity, the country now faces a labor shortage and there are concerns that the economic boost from immigration will only be temporary as the government is forced to spend significant amounts to integrate the newcomers.

Even though economic activity remains strong, a huge component of this uptick in activity and inflation has to do with the substantial stimulus measures and quantitative easing program implemented by the Central Bank. After flirting with deflation after consumer prices printed in negative territory for several years straight, the unconventional measures have helped headline prices climb back into positive territory.The price has not been small though, with the Riksbank already spending SEK 200 billion to acquire government bonds with an additional SEK 45 billion planned for the second half of the year.One question that remains is how the economy will react once stimulus measures are removed and if the economy will continue to perform at current levels.So far the moves have kept a lid on Krona strength and helped lift inflation, but abandoning stimulus might see those gains quickly reversed.

Swedish Krona Strength Concerning

While monetary policy remains highly accommodative, the Riksbank has insinuated that it is prepared to do more in an effort to go ahead and keep the Swedish Krona competitive.Aside from displaying an open willingness make monetary policy more expansionary, the Central Bank has also considered extending the duration of the current asset purchase program and even admitted a degree of preparedness to intervene directly in foreign exchange markets to go ahead and prevent a rapid appreciation of the Krona.However, based on the divergence between monetary policy in the United States and Sweden, there may be hope for Swedish policymakers that no further policy loosening is needed.Should the US Federal Reserve decide to raise interest rates, it will markedly decrease the pressure on Swedish officials to unilaterally intervene in the USDSEK exchange rate.

Higher interest rates may not be coming immediately for the US, however, recent testimony from Fed Chair Yellen continues to highlight that any movement would be data dependent.In spite of weaker labor data released earlier in the month, should the data prove an aberration while inflation continues to rise, the Federal Reserve might still be able to raise rates twice before the end of 2016.A rising rate environment would see the US dollar climb further from current levels, helping drive the USDSEK back towards multi-year highs of 8.8845 and alleviating pressure on the Swedish Central Bank.Additionally, a weaker Krona would help inflation continue to rise from current levels, a development that could conceivably be derailed should the Krona appreciate versus the US dollar and Euro.Based on this, until the USDSEK pair falls out of an 18-month range to the downside, any intervention is unlikely.

Looking Ahead

Even with the upcoming British referendum vote expected to raise volatility across European and international financial assets, USDSEK will continue to be more sensitive to US economic data as the Federal Reserve awaits confirmation of stronger economic momentum.An improvement in labor conditions combined with further upside in consumer price inflation could see the Federal Reserve move to raise rates faster than currently anticipated by market participants, helping alleviate pressure on the Krona.However, should action on rates be delayed further, Swedish Central Bank officials are likely to respond with lower rates, extended purchases, or direct exchange rate interventions which could drive the USDSEK pair higher.While risks for the pair remain to the downside considering the strong performance of the Swedish economy near-term, longer-term, a retest of multi-year highs in the pair is possible, especially if monetary policy in the two nations diverges further.