Riksbank expands QE and signals more

Broadly in line with Barclays’ expectations, the Riksbank kept its repo rate unchanged at -0.35% and decided to expand its QE programme.

Citing considerable global uncertainty and rising expectations that central banks abroad would likely pursue even more expansionary monetary policy, the Riksbank decided to expand its QE programme by SEK65bn to June 2016, so that total purchases will amount to SEK200bn (Figure 1). The size of QE expansion was more than our initial estimate of SEK40-50bn and will last longer than we previously expected. The policy rate was left unchanged at -0.35%, although, importantly, the projected repo rate path has been revised lower to -0.4% in 2016 (-0.3% in the September MPR) and -0.1% in 2017 (0.2% in the September MPR), signalling an additional repo rate cut, in our view (Figure 2). Despite the larger-than-expected QE expansion and dovish revisions to the repo rate, the SEK strengthened as markets continue to question the need for additional monetary policy stimulus by the Riksbank due to solid domestic fundamentals, the recent meaningful uptick in inflation and inflation expectations and the currency’s undervaluation.

We continue to expect an additional 10bp repo rate cut in December after the ECB policy meeting, but remain of the view that the Riksbank is close to the end of its easing cycle. Given our expectations for a time expansion of ECB QE in December (see ECB prepares the market for December , 22 October 2015) and the Riksbank’s recent reactivity to policy abroad, particularly in the euro area, we think the Riksbank will likely make policy more accommodative, cutting its repo rate by an additional 10bp shortly after the ECB’s meeting in December. However, we continue to question the need for additional policy stimulus and continue to think that the Bank is very close to the end of its easing cycle. Our EURSEK forecasts remain intact, and we continue to expect modest EURSEK depreciation further ahead.

Swedish inflation and inflation expectations are on an uptrend, but inflation forecasts have been revised slightly lower in the October MPR, acknowledging global disinflationary pressures. The Riksbank acknowledged that its expansionary monetary policy is having a meaningful effect on stabilising medium-term inflation expectations and contributing to a stronger Swedish economy, a fall in unemployment and a clear upward trend in spot inflation (Figures 3 and 4). However, inflation abroad will likely be lower than previously expected, pushing major central banks to pursue further easing for a prolonged period of time. Due to renewed global disinflationary pressures, the Riksbank no longer expects CPIF inflation to hit 2% in 2016, which is now expected to occur in Q1 2017, in line with our own projections. In terms of GDP, the Riksbank continues to project a solid pace of growth and has revised 2015 GDP forecasts higher to 3.3% from 3.1% in the September MPR. The 2016 forecasts have been revised lower to 3%, however, as some of the recent economic activity moderates. The economy is still expected to grow at a solid 2.7% in 2017.

The Riksbank remains concerned about an abrupt SEK appreciation and is pencilling a softer pace of SEK effective exchange rate appreciation over the forecast horizon. A prolonged period of SEK strength remains a key concern for the Riksbank, which remains uncomfortable with the way it has traded recently. With the inflation recovery still at a fragile stage, we continue to expect modest verbal intervention by Riksbank officials, highlighting the need for a weaker SEK. With this in mind and due to the downward revisions to inflation and the repo rate path, the Riksbank now expects a somewhat slower pace of currency appreciation over the forecast horizon (Figure 5). Indeed, the Riksbank has clearly targeted a weaker SEK since Q1 2015, partly helping in easing monetary conditions, which are close to levels last seen during the GFC (Figure 6). However, strong Swedish fundamentals have helped unwind losses following prior easing. Our valuation models continue to suggest material SEK undervaluation, and we continue to think that the Riksbank will be more comfortable in allowing currency appreciation once the inflation trajectory is firmly on track.

 Nikolaos Sgouropoulos – Foreign Exchange Research – Barclays