Sweden is one of the few countries that have tightened monetary policy post-crisis. However, that tightening cycle appears to have ended and the Riksbank is likely to keep rates steady when it meets this Wednesday.RECENT DEVELOPMENTS
The Riksbank meets this Wednesday and is widely expected to keep rates steady at 0.0%. At its last meeting in December, the Riksbank hiked the repo rate 25 bp to 0.0%. The rate path reported then suggested steady rates through 2023 and that path is likely to be maintained at tomorrow’s meeting. However, we expect a slightly dovish hold, as the bank has been very clear that downside risks remain in play.
January CPI data will be reported next Wednesday. Inflation has been edging higher but remains below the 2% target. Looking ahead, lower power and oil prices are likely to push headline inflation lower in the coming months. Many analysts look for inflation to move below 1%, which will surely reignite fears of a move back to negative rates.
Sweden’s Financial Supervisory Authority (FSA) announced an extra meeting in March to discuss Swedbank. The bank’s governance and anti-money laundering policies have come under scrutiny after its Baltic subsidiaries were accused last year of channeling as much as $155 bln of dirty money into the global financial system. Next month, both Swedish and Estonian authorities are set to publish their findings of probes into Swedbank’s activities in the region.
The political landscape has settled down after an extended period of uncertainty. The September 2019 elections saw no clear winner emerge. After a deadlock lasting more than four months, center-left Prime Minister Stefan Lofven and his Social Democrats were able to form a minority government that excluded both the far-right and far-left parties. The vote was 115 for, 153 against, and 77 abstentions. In Sweden, a government can be formed with less than a majority of the 349 total seats in Parliament as long as there is not a majority voting against it. The next election is not due until 2022 and most observers do not see early elections.
A BRIEF HISTORY LESSON
To date, there have only been a handful of central banks that have taken their policy rates negative: Denmark (since 2012), Sweden (from 2015 until this past December), ECB (since 2014), Switzerland (since 2014), and Japan (since 2016). Let’s look at how Sweden got there and back again.
The Riksbank has three key policy rates. The repo rate is the main one that was introduced in 1994. This is the rate at which the central bank lends money to commercial banks for a period of seven days via securities repos. The other rates are the overnight deposit and overnight lending rates, which typically (but not always) move in tandem with the repo rate.
During the Great Financial Crisis, the Riksbank cut its repo rate from 4.75% in September 2008 to 0.25% in July 2009. This pushed the overnight deposit rate down to -0.25%, which represented its first foray into negative rates. It started a modest tightening cycle in July 2010, hiking the repo rate 25 bp to 0.50% and then again to 0.75% in September. This took the deposit rate back to 0%, and so negative rates only prevailed for a little over a year. Further hikes took the repo rate to 2.0% in July 2011, which took the overnight deposit rate to 1.25%.
The Riksbank reversed course and started cutting rates in December 2011. A slow but steady easing cycle took the repo rate down to 0.25% in July 2014, which pushed the overnight deposit rate back into negative territory at -0.50%. The Riksbank then cut the repo rate to 0% in October 2014 and then took it negative with a 10 bp cut in February 2015. This pushed the overnight deposit rate further into negative territory. Three more cuts took the repo rate to the low of -0.50% by early 2016. The overnight deposit rate stood at -1.25% then.
The first 25 bp hike of the tightening cycle came in January 2019. The second one came in January 2020 that took the repo rate to 0.0%. However, in October 2019, the Riksbank announced changes to its operational framework in an effort to simplify it in two stages. In the first stage, the bank narrowed the spread between the repo rate and the deposit rate to only 10 bp from 75 bp previously. In the second stage that will take place within two years, the overnight lending rate will be set at 10 bp above the repo rate. From its website: “These changes will not have any monetary policy effects, as the Riksbank will continue to be able to ensure that the overnight rate stays close to the repo rate.”
Former US Treasury Secretary Summers co-authored a research piece for the National Bureau of Economic Research last year entitled “Negative Nominal Interest Rates and the Bank Lending Channel.” To summarize, the authors wrote that “Based on the empirical evidence, we construct a macro-model with a banking sector that links together policy rates, deposit rates and lending rates. Once the policy rate turns negative, the usual transmission mechanism of monetary policy through the bank sector breaks down. Moreover, because a negative policy rate reduces bank profits, the total effect on aggregate output can be contractionary. A calibration which matches Swedish bank level data suggests that a policy rate of -0.50 percent increases borrowing rates by 15 basis points and reduces output by 7 basis points.”
The economy is slowing. The OECD forecasts GDP growth slowing to 1.2% in both 2020 and 2021 from an estimated 1.4% in 2019. GDP growth recovered to 2.0% y/y in Q3 from 0.5% in Q2. However, monthly data so far in Q4 suggest some deceleration ahead. As such, we see some downside risks to these growth forecasts.
Sweden should be viewed as a potential play on global growth. Exports account for over 30% of GDP, higher than neighboring Norway (28%) or other growth-sensitive economies such as Australia (18%) and Canada (26%). Sweden’s top exports are machinery, vehicles, paper, pharmaceuticals, and steel. Sweden’s largest export market is Germany, and so the slowdown there has had knock-on effects domestically.
Price pressures are relatively low. Headline inflation picked up to 1.8% y/y in both November and December, the highest since June 2019 but still below the 2% target. Underlying inflation picked up to 1.7% y/y in both November and December, also the highest since June 2019. Unemployment at 6.0% remains near the cycle lows, yet there has been very little so far in the way of wage pressures.
The Riksbank will keep an eye on rising inflation, but we see no policy response near-term as the economy slows. The Riksbank’s latest expected rate path shows the policy rate remaining at the current level until the end of the latest forecast period in 2023. That path should be maintained at tomorrow’s meeting. Much will depend on the global backdrop and oil prices but for now, we see steady rates this year.
Despite the period of negative interest rates, the IMF describes Sweden’s banking sector as “robust.” The agency noted that the banks maintain high profitability and capital levels along with sound loan books. Regulators have will not hesitate to use macroprudential measures to strengthen the banking system. In recent years, authorities have raised minimum amortization on certain new mortgages as well as increasing the countercyclical capital buffer for banks by half a percentage point to 2.5%, the highest in Europe.
The fiscal accounts remain solid. The OECD sees the budget surplus falling slightly to 0.2% of GDP in 2020 from 0.4% in 2019. These are a bit lower than previously forecast, as slow growth has taken a toll. Note that Sweden modified its fiscal framework in 2016, lowering the medium-term target for the budget surplus from 1% of GDP to 0.33% effective 2019. It also set a debt/GDP benchmark ratio of 35% then. Prudent fiscal stance should allow policymakers to use countercyclical stimulus if the economy slows significantly in the coming quarters.
The external accounts are improving. The OECD sees the current account surplus widening to 4.5% of GDP for both this year and next from 3.1% in 2019. Exports have contracted y/y in USD terms since August. However, import demand has fallen even more and so the 12-month trade balance has moved back into surplus over the course of 2019. As such, we see some slight upside risks to the current account forecasts. Lastly, Sweden’s Net International Investment Position has risen to nearly 20% of GDP, the highest on record. As such, its external vulnerability remains fairly low.
The Swedish krona continues to underperform within the majors. In 2019, SEK was -5.5% and the worst performer in the majors. So far in 2020, SEK is -2.8% and is ahead of only the worst performers AUD (-4.2%), NZD (-4.9%), and NOK (-5.0%).
In early February, EUR/SEK traded at its highest level since November. The pair has since moved lower even as EUR/NOK moved higher. If oil continues to slide, look for NOK to continue underperforming SEK. If so, then the NOK/SEK cross would likely move below the December 2019 low near 1.0295 and then possibly test the December 2018 low near 1.0210 and then the February 2018 low near 101.15.
Swedish equities have started to outperform. In 2019, MSCI Sweden rose 24.4% compared to 25.8% for MSCI World. So far in 2020, MSCI Sweden is up 6.4% vs. 3.2% for MSCI World. With the Riksbank now on hold for the foreseeable future, we expect Swedish equities to continue outperforming, as suggested by the VERY OVERWEIGHT rating for Sweden generated by our DM Equity Allocation model.
Swedish bonds are underperforming. The yield on 10-year local currency government bonds is -13 bp YTD and is ahead of only worst DM performers Japan (-3 bp), Israel (-4 bp), Singapore (-4 bp), and Portugal (-12 bp). With inflation likely to remain low and the Riksbank now on a dovish hold after a short tightening cycle, Swedish bonds should start to outperform more. Our own sovereign ratings model shows Sweden’s implied rating steady and solidly at AAA/Aaa/AAA.