The risky masterstroke of the Swedish central bank

For a moment, the Swedish central bank seemed to be shooting itself in the fingers with an early interest rate cut. The Riksbank would rather see a strong crown than a weak one. But the currency is now regaining ground and the Swedish economy is climbing out of the trough.

In recent years, there has been only one thing that kept central bankers awake at night: high inflation. Meanwhile, other issues are also attracting more and more attention. In Sweden, for example, the Riksbank performs a clever balancing act. On the one hand, inflation in the Scandinavian country has still not fallen to the official target of 2%. But on the other hand, the economy needs a boost. After a recession in 2023, Sweden is heading for a growth rate of just 0,7% in the current year. An interest rate cut is a proven method to boost the economy. Moreover, there are few countries where this has more impact than in Sweden.

High debt burden and short-term mortgage
That requires some explanation. In recent decades, the debt burden of Swedish consumers has increased significantly. Just before 2000, total household debt was slightly smaller than average income. However, that debt has now doubled. In addition, Swedes take out their mortgage for a relatively short period. According to the Riksbank, the average remaining term is less than two years. In the Netherlands, for example, this is more than six years and in Belgium even more than twelve years. If interest rates rise or fall, this will affect households' mortgage costs much more quickly in Sweden than in many other countries. The interest rate cut that the Riksbank announced at the beginning of May was therefore good news for the economy.

Interest move works out well
However, an adjustment of the policy interest rate not only has an impact on the economy, but also on currency markets. There, a lower interest rate makes it less interesting for financial institutions and other parties to hold assets in the currency in question. In the wake of the interest rate cut, the Swedish krona took a step back. And the Riksbank would rather not see that. A cheaper currency makes all kinds of items from abroad proportionately more expensive. These rising prices fuel inflation, which the central bank is trying to get under control. Yet the Riksbank's interest rate move increasingly appears to be turning out to be a masterstroke instead of a miss.

All eyes on the ECB
Inflation expectations have hardly increased after the interest rate cut and attention on currency markets is increasingly shifting to the European Central Bank (ECB). It will be very strange if the policy interest rate in Europe is not lowered a notch next Thursday. Due to the prospect that the interest rate difference will soon narrow again, the crown has risen rapidly since mid-May to the highest level since the end of March. What the exchange rate will look like in the coming weeks depends mainly on the ECB's outlook. If more interest rate cuts are coming, the krona may continue its advance. But it is important that the Riksbank resists the temptation for the time being to boost the economy with a new interest rate cut.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.