The Riksbank unexpectedly decided yesterday to cut the Repo rate by 0.25% to 0.25% as “the weak development of the economy requires a somewhat more expansionary monetary policy”, in the Riksbank’s words. The Central Bank also decided to offer loans of up to SEK 100bn to commercial banks at a fixed interest rate and with 12-month maturity. The Swedish CB’s projections are for the GDP to fall by 5.4% in 2009 (vs. 4.5% contraction of previous estimates) and to edge up 1.9% in 2010. The Repo rate is expected to stay at 0.25% until the second half of 2010. In the subsequent years, the Riksbank looks for a rapid increase in the Repo rate, which is seen at around 4% in mid-2012.
The Repo rate cut is likely to have negative consequences on the Swedish Krona (the currency weakened to 10,8716 against the Euro immediately after the announcement of the rate cut) in the short term, particularly against the Euro. Indeed the interest rate differential is likely to trigger a prolonged weakening of the Krona as we do not see the ECB cutting rates (from the current 1%, which was confirmed during yesterday’s ECB meeting) in the next few months.
In the direction of a weakening of the Krona is also a level of inflation that is forecast to remain slightly more elevated than in the Eurozone. Excluding the repercussions of lower mortgage rates and energy price inflation, the annual rate of inflation should average 2% in 2009.
Financial market turbulence and concerns over the developments in the Baltic countries are another two factors that point against a Krona appreciation.
However, once the financial crisis is resolved, the Swedish Krona will likely appreciate sharply versus other international currencies. In a recent economic commentary ( The long-term development of the Krona ) the Riksbank predicted a strengthening of the Krona (+10-15%) in the years ahead. The kick-start for an upsurge in the Krona will come from signs of an economic recovery in Sweden, which will boost expectations of a quick reversal of the expansionary monetary policy.