Scandie Central Bank Preview

The Riksbank and Norges Bank both meet this week. The two are on different trajectories that should be underscored by the meeting outcomes; while the Riksbank is widely expected to stay on hold, we see the risk of hawkish language from the Norges Bank. This in turn could lead to some NOK outperformance that sees the NOK/SEK cross recover some of its recent losses.

RECENT DEVELOPMENTS

Riksbank meets Tuesday and is expected to keep policy unchanged.  It is too soon to expect further stimulus since at its last meeting July 1, the bank surprised markets with an expansion of QE whilst keeping rates on hold at zero.  It expanded its purchase program to SEK500 bln from SEK300 bln, extended it to mid-2021, and added corporate debt to its program beginning this month. The bank’s flat rate path was extended to at least the beginning of 2023 after being kept flat for only one year out at its April meeting due to the uncertain situation.

Price pressures in Sweden remain relatively low. Headline inflation picked up to 0.8% y/y in August, the highest since February. Underlying CPIF inflation also picked up to 0.7% y/y in August, also the highest since February but still well below the 2% target. Unemployment was 9.1% in August, just a tick below the pandemic highs in June and July and suggesting very little in the way of wage pressures. At this point, there is simply no reason for the Riksbank to deviate from its current dovish settings.

Norges Bank meets Thursday and is expected to keep rates at zero.  However, there is a risk that it delivers a slightly hawkish hold. At the June 18 meeting, the bank adjusted its expected rate path to show the policy rate rising to 0.5% in 2023 from 0% currently.  At its last meeting August 20, Norges Bank noted the improved pace of the economic recovery.  This means that the bank could reign in its dovish language this week about keeping rates at current levels “over the next couple of years” and perhaps adjust its rate path up modestly again. Why?

Norway’s inflation figures surprised on the upside in August. Headline CPI came in at 1.7% y/y, the highest since January and moving closer to the 2% target. Core inflation accelerated a couple of ticks to 3.7% y/y, the highest since July 2016.  It’s possible that this leads Norges Bank to modify its forward guidance this week but we still see very little risk of a hike until late 2022 at the earliest.

 

INVESTMENT OUTLOOK

Both nations should be viewed as a potential play on global growth. Swedish 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. Similarly, Norway is viewed as an oil play, which in itself is a play on global growth too.

Yet the two currencies are at the opposite ends of the league table. The Swedish krona is the best performer within the majors, up 5.5% YTD. In 2019, SEK was -5.5% and the worst performer in the majors. On the other hand, the Norwegian krone is the worst performer in the majors at -5.5% YTD. In 2019, NOK was -2% vs. the dollar and in the middle of the pack.

In late July, EUR/SEK traded at its lowest level since November near 10.2165. The pair has since moved higher and a break above the 10.45 area would set up a test of the June high near 10.60. EUR/NOK bottomed on August 31 near 10.373 and has since followed EUR/SEK higher and is on track to test its June high near 11.02. We need to see a break of the 11.19 area to set up a test of the April high near 11.70.

This recent NOK underperformance has seen NOK/SEK drop over 4% this month. Whether this drop continues will hinge in large part on the central bank meetings this week. One potential monkey wrench is if oil continues to slide, in which case NOK could start underperforming SEK even more. To be continued.

Given the different central bank trajectories expected this week, we think the NOK/SEK could reverse and move higher. If so, then the pair would face resistance at the 200-day moving average near .9915 currently. A break above that would set up a test of the February high near 1.0570. On the other hand, a break below the April low near .9345 would negate our call and instead sets up a test of the March low near .8530. Retracement objectives from the March-June rise in NOK/SEK come in near 0.9415 (38%), 0.9245 (50%),and 0.9075 (62%).

 

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.”

The Norges Bank has never gone negative. The policy rate was quickly cut during the financial crisis from 5.75% in September 2008 to 1.25% in June 2009. Norges Bank hiked rates starting in October 2009 to over the course of 2010 and 2011 to 2.25%. It then reversed and started cutting in December 2011 a trough of 0.50% in March 16. Rates remained there until September 2018, when a tightening cycle began that took the policy rates up to 1.5% in September 2019. When the pandemic hit, Norges Bank reacted quickly and cut rates to zero in May and that’s where rates remain today.

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.”