The Riksbank is widely expected to cut the repo rate and lower its rate path on 3 July.
Here, we sketch three scenarios and the expected impact on EUR/SEK. Scenario II is the most likely, in our view. This could offer opportunities to enter short positions in EUR/SEK.
Could we see a repeat of the summer 2013 in EUR/SEK?
The Riksbank might manage to weaken the krona further with a soft message next week (3 July). The key arguments for it to deliver a rate cut and postpone the first hike include too low inflation and lower-than-expected global rates in the wake of the actions of the ECB and Norges Bank, which, if not taken into account, could result in unwelcome SEK appreciation. Here, we take a closer look at the possible market effects after the Riksbank’s meeting. The question is, what is ‘required’ in order to over deliver relative to market expectations (money market pricing)? We sketch three scenarios.
Scenario I
If the Riksbank (i) cuts the repo rate 25bp, (ii) continues to indicate a marked easing bias in the near term and (iii) in line with our forecast shifts the first hike to Q3 16 from summer 2015, it would exceed current pricing by some 25bp. Such a delay of the first hike would be in sync with what Norges Bank did last week. A model approach suggests that this outcome, if it were today, would easily send EUR/SEK’s fair value (currently just below 9.10) above 9.30, even to 9.40. Plus, there would be a risk of overshooting.
But that would mean that the Riksbank slashes its repo rate path from 2.20% to 0.75%, that is, by 150bp, including the predicted rate cut and it is highly doubtful that it would make such a significant or drastic adjustment in one blow given how it has reasoned so far. We do not see this scenario as the most likely, but it should not be fully ruled out.
Scenario II
A more likely scenario for the Riksbank is (i) a rate cut to 0.50%, (ii) a continued significant easing bias and (iii) to confine itself with a less aggressive delay of the first hike to perhaps Q1 16 (from summer 2015). Such a change, if it is credible, would match current pricing and in principle be neutral for EUR/SEK and even give some support to the krona, as it has already overshot relative to fair value. We admit, though, that being credible is a strong assumption given the recent marked discrepancies between the Riksbank’s forecast and market pricing. We see this as the main scenario. If it materialises, we are inclined to begin building short positions in EUR/SEK.
Scenario III
Any alternative spanning between Scenario II and leaving the repo rate unchanged would be to under deliver relative to market expectations and would send EUR/SEK sharply lower. We see this as an extremely unlikely outcome.
A repeat of 2013?
It is clear that EUR/SEK is vulnerable on the upside with one week to go before the Riksbank rate decision. However, it should not be ruled out that we could get a repeat of June 2013 when on 19 June Norges Bank unexpectedly lowered its inflation and rate path, which not only sent EUR/NOK higher but also had a significant impact on EUR/SEK on speculations that the Riksbank would be equally dovish.
To Read the Entire Report Please Click on the pdf File Below