EUR/SEK to Spike Higher on 25bp Rate Cut, but Only Temporarily

We expect the Riksbank to significantly lower its GDP forecast, raise the unemployment forecast and lower the inflation forecast in the monetary policy report to be published along with the rate decision tomorrow at 09:30 CET.

Macro-economic indicators suggest that 2011  ended at a much weaker note than the Riksbank projected in December. We expect GDP Q4 to decline by 1.2% q/q; in the December report the Riksbank expected +0.05%. The Riksbank has GDP growth at 1.7% for 2012, we have -1.0%. Meanwhile, labour market data are levelling off and unemployment is starting to rise. The number of layoffs rose sharply in January, which suggests that unemployment will move higher in 2012, which is in line with our scenario but in contrast to the Riksbank projecting a flat unemployment rate. 

Inflation has come out in line with the Riksbank forecast, but looking ahead our macroeconomic forecast implies inflation will run substantially below the Riksbank target for almost the whole forecast horizon. The krona is markedly stronger (4%) in terms of TCW than the Riksbank anticipated, which dampens both activity and inflation more than assumed. On a separate note, credit growth has diminished further and house prices have come down; a process likely to continue, as such facilitating for Board members to ease. 

Based on these developments we expect that the Riksbank will cut the repo rate by another 25bp tomorrow, while at the same time indicating a slight probability of further rate cuts going forward. The immediate reaction should be lower short rates and weaker SEK (higher EUR/SEK) given the fact that the money market is only pricing in some 60% probability of 25bp. However, the negative impact is expected to be limited and short-lived, not least as the interest rate forecast is not expected to confirm market expectations of further rate cuts going forward.  If the Riksbank surprises us by leaving the repo rate unchanged, EUR/SEK is likely to fall sharply and immediately, testing the 8.70 support.

We are strategically bullish on the krona given its top-notch quality credentials and valuation aspects. The number of countries with the highest rating from all three big rating agencies has shrunk to 13. Some of these have negative outlook. The fact is that there are only seven (!) countries left with stable top notch rating – six currencies with a flexible exchange rate and one of the “finest” among these is the Swedish krona. Taking into account the fundamental backdrop and long term valuation the krona is one of the most attractive among these six currencies. Valuation metrics even suggest that SEK is still undervalued vs. EUR (PPP 8.40/50). 

If we are right on the Riksbank, we should get better entry levels to sell EUR/SEK. Our medium target is 8.50.