Riksbank React: Hawkish Optionality

Summary

• The Riksbank hiked the policy rate by 25bp to 3.75%, as expected. At least one more hike is forecast for the September or November meeting.
• QT also sped up to SEK 5bn (nominal: 4.2bn; real: 0.8bn), retaining focus on longer maturities.
• Focus on inflation outturns remain – there are three releases before the September meeting, and core CPIF needs to end up below +6.8% YoY to provide them some comfort.
• The labour market remains tight, but the Swedish wage formulation model provides some comparative comfort.
• A quarter of the Riksbank’s FX reserves could be hedged starting this autumn. This will not affect monetary policy.

Riksbank Own Hawkish Optionality

The Riksbank hiked the policy rate by 25bp to 3.75% – this time with no reservations – and revised the rate path to a touch above 4%, in line with our expectations. The revised policy rate forecast peaks at 4.05% in Q1 2024, indicating at least another hike to follow in September or November (Chart 1).

Alongside the decision on the policy rate, the Riksbank increased the pace of quantitative tightening (QT) to SEK 5bn from SEK 3.5bn, starting in September. The Riksbank’s SEK 5bn of QT will continue to target longer maturities and favour nominal (SEK 4.2bn) over real (0.8bn) bond sales (Chart 2). The Riksbank noted that it is not planning to sell its holding of non-government bonds.

Data Dependent = Watch Core Inflation

Looking forward, the Riksbank note that they continue to favour increases in the policy rate as the most effective tool to tighten policy further. The pace at which they do so will be data dependent: ‘New information, and how it is expected to affect the economic outlook and inflation prospects, will be decisive in determining the design of monetary policy going forward.’ There are three inflation readings before the September meeting, CPIF is forecasted to have reached +4.7% YoY by the August reading while core CPIF is forecasted to have declined to +6.8% YoY (Charts 3 and 4).

SEK Remains an Issue

Unsurprisingly, a weak krona remained an issue for the Riksbank. The Riksbank sees it a risk to larger price increases in the current situation of high inflation. Latest forecasts see KIX (Sweden TWI FX index) appreciating (depreciating SEK) to average 130.1 through Q3 (Chart 5). As it stands, the index sits at 130. Should SEK weaken more than expected, the Riksbank could hike past 4.5% (Chart 6). For arguments sake, should inflation prove weaker than expected, the Riksbank would cut the policy rate in H1 2024.

And, in usual Riksbank fashion, they dived into a pertinent issue: the strong labour market (both in Sweden and abroad). And while it is indeed strong in Sweden, the Riksbank has retained their view that wage increases in Sweden have been lower than those abroad, and should, therefore, give the Riksbank an easier time in curtailing inflationary pressures.

Riksbank Announce Potential for FX Hedging

Lastly, the Riksbank also announced that they are considering hedging part of their FX reserves. Looking through the details, if it was to go through, a quarter of their SEK 410bn of FX reserves would be hedged using forwards or swaps, starting as soon as ‘early autumn 2023’. It would mean around $10bn of hedging with a realistic selling of 6-7bn of USD/SEK and 2-3bn of EUR/SEK. The pace is unknown; transactions would be spread out over an ‘appropriate period of time’. However, given their intention is to hedge against a SEK appreciation, and their forecasts are for SEK to marginally strengthen into 2024, this could take place into year-end. It is important to note, the Riksbank are doing this for hedging purposes, not for FX intervention reasons.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively. 

Photo Credit: depositphotos.com

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