Monetary Policy & Inflation | Rates
Riksbank February 2023 Review
- By Ben Ford
- 8 min read
Summary
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- Governor Thedéen’s first meeting proved hawkish. We expect a 25bp hike to follow in March. Markets are pricing the possibility of another 50bp.
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Summary
- Governor Thedéen’s first meeting proved hawkish. We expect a 25bp hike to follow in March. Markets are pricing the possibility of another 50bp.
- The meeting revealed a plan for active QT; the Riksbank will sell SEK3.5bn per month of government bonds, starting April and excluding July and August. Largest holdings are in the five-, 10- and 15-year bonds.
- New forecasts reveal a five-quarter recession with a small weakening to the labour market. (Core) inflation is expected to return to target by Q4 2023 (Q1 2024).
Market Implications
- SEK has found a solid footing. A hawkish narrative likely continues next week while key data will not arrive until the week after in Europe. Weaker equities are supporting SEK, too. There is value in fading EUR/SEK strength over the next week, but the trend higher will last.
Governor Thedéen Starting on Hawkish Footing
Governor Thedéen’s first meeting proved hawkish. The Riksbank hiked the policy rate by 50bp to 3.0% and put forward plans to sell government bonds from April and to increase the offered issue of Riksbank Certificates. A hawkish policy path revision and desire for a stronger currency adjoined the decision.
Actively Reducing Balance Sheet
New plans for the balance sheet proved a surprise. Going forward, it will be reduced at a faster pace, selling SEK 3bn nominal government bonds and SEK 0.5bn real government bonds per month, starting in April and excluding July and August (Chart 1). The operation will focus on bonds with maturities from 2027 onwards and was proposed without an end date. As of 31 January, the Riksbank are most heavily invested in the five-, 10- and 15-year buckets. They own an equivalent to c.50% outstanding (Table 1).
Previously, they let bonds passively mature off the balance sheet. While this has run its course in treasury bills, rapid balance sheet reduction will occur over 2023 with 20% of their nominal holdings maturing this year (Chart 2).
Riksbank Certificates to Prop Up Money Market Yields
The Riksbank also decided to resume offering volumes of Riksbank Certificates equal to the banking system’s entire liquidity system, from 14 February 2023. When the counterparty invests in the certificate, the Riksbank borrows liquidity from the banking system at an interest rate corresponding to the policy rate. Moreover, to facilitate the banks’ liquidity management, Riksbank Certificate can be resold. It means, bridging the gap in the liquidity should see overnight market yields 5-10bps higher, making it more attractive for foreign investors (Chart 3). That is, this is a combined effort to support SEK which is proving a touch stronger than forecasted through Q1, though the Riksbank forecasting record is ambitious at best (Chart 4).
Hawkish New Forecasts
25bp Hike Forecasted in April
Revisions to the forecasted rate path proved more hawkish than we and the markets expected. The policy rate is set to increase 25bp further through Q2, indicating a likely 25bp hike at the April meeting, while the peak policy rate is thought to be a touch higher (Chart 5). It means 50bp is a risk in April, or another 25bp hike further afield.
Inflation Returning to Target in 23Q4/24Q1
It’s only down from here; for inflation at least. That’s what the Riksbank are forecasting. With headline inflation (CPIF) expected to have peaked 10.2% YoY, the Riksbank are confident of a return to target by November this year (Chart 6). A slower, return to the 1-3% target band is expect for core inflation (CPIF ex-energy; Chart 7). However, warning signs are flashing. While core inflation has arguably peaked, progress is slow and 3M/3M inflation momentum remains above average (Chart 8).
Five-Quarter Recession with Minimal Effect to Labour Market
Other economic forecasts were little changed. GDP is expected to print -0.9% through 2023, 0.1pp higher than before, and is unchanged at 1.0% for 2024. Meanwhile, unemployment is expected to reach 8.3% by year end, accompanied by a 68.2% employment rate (Charts 9, 10 and 11).
Market Implications
SEK added to morning strength with EUR/SEK falling 2.5% on the day (Chart 12). SEK’s revival came as swap yields rose across the curve. In the near-term, the EUR 2Y swap rate may find itself moving sideways until new data can push market expectations above 3.5% terminal rate (Henry’s expectation). Key data includes 21 February PMIs and 23 February final CPIs. In contrast, next week is likely to be flooded with hawkish Riksbank talk. Governor Thedéen is set for his first speech (14 February: ‘The economic situation and current monetary policy’), Deputy Governor Per Jansson (hawk; 16 February) will review whether the policy rate is having an effect on inflation (November meeting minutes revealed he thought the Riksbank has been too cautious so far), while February meeting minutes will give us a broader view of the new board.
Equities are proving a tailwind. Correlations between KIX and US and European equity indices have returned (Chart 13). However, this time, they are positive – KIX higher = SEK weaker – meaning a sell off would prove positive for SEK. Meanwhile, KIX holds a negative correlation to the VIX. Therefore, SEK may prosper in an equity sell-off with higher implied volatility.
In short, we think there is value in fading EUR/SEK rallies next week. There on, we continue to believe EUR/SEK will trade higher.
Summary
In short, Governor Thedéen’s first meeting proved hawkish. The policy rate path was revised higher than most expected, while the change to QT was a surprise. We expect a 25bp hike in March while markets are pricing the risk of a larger move.
SEK seemed to finally have found solid ground. Speeches (14 February: Thedéen; 16 February: Jansson) next week likely add to the case. Looking forward, there is value in fading EUR/SEK rallies over the next week. There on, we continue to believe EUR/SEK will trade higher.