R rushing to cut interest rates at the peak of the financial crisis, the next challenge for central bankers is when to start the tightening cycle. The National Bank of Australia has already taken the plunge and hiked rates twice this year, while last month Sweden’s central bank signalled it would raise interest rates in the summer from 0.25 to 0.5 per cent. The Riksbank reiterated its plan to start tightening rates in an announcement yesterday. This fuelled a mini-rally in the Swedish krona, which appreciated against the US dollar, the euro and sterling, as investors rushed to take advantage of any widening of the interest rate differential. But investors shouldn’t get excited – any krona strength should be short-lived.
At the same time as hiking rates, the Riksbank also lowered its growth expectations for this year from 2.5 per cent to 2.2 per cent. There is a risk that economic growth could fall even further, says Ben May, European economist at the consultancy Capital Economics. He predicts that growth could rise by a meagre 1 per cent and predicts that the Riksbank may actually delay its rate hike if growth is disappointing.
Sweden has a difficult balancing act ahead, says Duncan Higgins, senior analyst at Caxton FX. “The Riksbank will be wary of a stronger krona,” he says. “A weak pound is definitely helping the UK’s economy to recover and the Riksbank needs to make sure a stronger currency doesn’t put the recovery at risk.”
A weaker currency makes sense for Sweden’s economy in the coming months for two reasons. Firstly, unemployment is close to 10 per cent. This could have a more serious implication for growth in Sweden than its Nordic neighbours, since services make up a whopping 70 per cent of its economy (see chart). Not only could low interest rates boost consumption, they would also be welcomed by business. Some of Sweden’s largest companies, including phone manufacturer Ericsson, have been hurt badly by the recession.
Secondly, an election is planned for 19 September, which should mean a delay in rate changes. Also, the government deficit is expected to increase to 3 per cent of GDP this year, according to the OECD, and it could increase further. Prime minister Fredrik Reinfeldt has pledged to increase stimulus funds by nearly Skr5bn this year, which comes on top of an already expansive budget that pushed the size of the government’s stimulus programme to 1.2 per cent of gross domestic product for 2010. A weak krona would help to heal government finances.
If the Swedes do see sense and decide to delay their rate hike until later in the year, forex traders should be ready for a sharp turn-around in the krona’s fortunes. The best way to short the currency is against the dollar, as the euro remains under pressure because of Greece. Investors should keep a sharp eye on Stockholm.