Riksbank set for 50bp rate hike on weak krona and tight jobs market

The Riksbank signalled back in November that it was very close to the top of its tightening cycle, and its published interest rate projection pointed to one final 25bp hike this month. But since then, the European Central Bank has become yet more hawkish even as the Federal Reserve indicates it’s nearing the peak. On a trade-weighted basis, the krona is even weaker than during the financial crisis. According to the Riksbank’s in-house KIX exchange rate index, SEK is almost 5% weaker than it had projected back in November.

The jobs market is also historically tight. Wage negotiations are underway, and inflation expectations among both employer and employee organisations are off their highs but remain well above the levels we’ve seen over the past decade. Around 90% of Swedish employees have their wages set by collective-bargaining, among the highest rate in Europe, and these talks will set the tone for pay growth across the economy.

All of that suggests the Riksbank will hike by 50bp this week, and signal there’s more to come. But this is where life gets complicated for new Governor Erik Thedéen. The reality is that Sweden’s economy is under pressure, particularly when it comes to housing. 44% of Swedish households have a mortgaged property, and two-thirds of this lending is on floating rates. Unsurprisingly, house prices are so far down 15% from the peak. The latest activity data doesn’t look pretty either, with fourth quarter GDP coming in sharply negative.

Against the backdrop of this growth/inflation trade-off, we think the Riksbank will signal one further hike in April worth 25bp. That’s likely to mark the top of this cycle.

It’s hard to see a sharp recovery in the very near term for the krona. Markets are increasingly pricing in the risk that the Swedish economy will face a black swan scenario of high inflation, recession and housing crash: EUR/SEK is trading around 2.5% below its short-term fair value, according to our calculations.

A dovish surprise would risk sending the wrong signal to markets: that fighting inflation is no longer the primary goal. That may ultimately cause more pain through imported inflation as SEK accelerates its fall and the ripple effect to the mortgage market may be even worse than a 50bp hike. Staying hawkish and preventing a fall in SEK rates appears to be the only way forward for the Riksbank at the moment.

EUR/SEK is trading around 11.40 at the time of writing, still relatively close to the 11.68 record highs from March 2009. Averting a SEK slump to those record levels is job number one for the Riksbank right now, and we think a hawkish 50bp hike today can reduce pressure on the krona.