160916 sweden watch by ABN AMRO

Sweden Watch

Group Economics Macro & Financial Markets Research

16 September 2016

Change in policy bias soon?  The Riksbank’s super accommodative monetary policy… Georgette Boele Co-ordinator FX & Precious Metals

 … has fostered economic growth, has lifted inflation and has kept the

Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com

krona weak  Domestic inflationary pressures are building because of strong growth  Accommodative monetary policy is no longer necessary…  …but the Riksbank will be cautious to abruptly change its policy  We expect a change in guidance at the end of this year…  …and this should give strong support to the krona Accommodative monetary policy but for how long? Since the end of 2011, the Riksbank has eased monetary policy. It has cut interest rates into negative territory and carried out extensive purchases of government bonds. At the end of 2016 these purchases will amount to SEK 245 billion. In its latest monetary policy report the following arguments are used to keep monetary policy accommodative: -

uncertainty abroad,

moderate pace of the global economy,

low inflation in many countries and

expansionary monetary policy abroad.

Repo rate cut into negative territory %

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 96

Riksbank repo rate Source: Riksbank, Bloomberg

The Riksbank has also recognised that domestic economic growth has been strong, inflation is rising and the labour market is strengthening. The central bank is a flexible

Insights.abnamro.nl/en

Sweden Watch - Chan nge in policy y bias soon? ? - 16 Septe ember 2016

inflatio on targeter as itt focuses on prrice stability at 2% and its pollicy should also o attain sustain nable growth a and a high level of employmen nt. In its forwarrd guidance, it has indicatted that it expe ects inflation to be close to 2% % when it will inncrease the rep po rate in H2 2017. In this researc h note we do a deep-dive in the t economy aand ask if accommodative policy should remain in place and what w its effect will w be on the kkrona.

In the past a weake er krona lifted import pric ces creating i nflationary pressures In the past, domesticc inflationary prressures were weak and the eeconomy was vulnerable. v By ado opting a super accommodativ ve monetary po olicy stance (neegative rates, QE, Q dovish forward guidance and d verbal interve ention) the Riksbank weakenned the krona and a fostered economic growth. Th he weakening of o the krona in the period Julyy 2013 until Jully 2015 resulte ed in higher infllationary press sures because of higher impoort prices. The graph g below shows that developm ments in the kro ona are quickly y reflected in im mport prices. Fo or example, if the krona k weakenss sharply imporrt prices rise an nd vice versa.

…and d weaker SEK K resulted in inflationary pressures p Import price p index % yoy

SEK TWI % yoy (reversed)

-30

-20

-10

-5

-10 96 98 00 02 9 0 04 Import price indexx (lhs)

20 06 08 10 12 14 16 Swedissh krona TWI (rhs, reversed r scale)

Source: Thomson Reuterrs Datastream, Blo oomberg

Now a strong econ nomy has cre eated domesttic inflationarry pressures… … The ec conomy has grrown strongly in n the first half of o this year. Fixxed investmentt, private consum mption and govvernment cons sumption all contributed positiively to GDP growth (see graph below). In conttrast, net exports reduced gro owth as imports ts grew at a hig gher pace w currency.. This is a signaal of strong domestic than exports despite the relatively weak deman nd.

Econ nomic growth h is strong… Contribu ution to GDP, perccentage points yo oy

8 6 4 2 0 -2 -4 -6 -8

0 08

10 0

Priv. cons.. Net exp.

Govt. cons. c GDP

Source: Thomson Reuterrs Datastream

15 Fixxed Inv.

Sweden W Watch - Chan nge in policy y bias soon? ? - 16 Septe ember 2016

As a re esult of the stro ong economy, domestic inflattionary pressurres have been building as well. For F example, si nce March 201 16 service secttor price inflatioon has been co onsistently above 2.0%. What iss more, inflation n of domestic production p pricees has risen ab bove 2.0% over th he last 3 month hs. In other worrds, domestic inflationary preessures in the economy e are buildin ng.

Infflation is pick king up…

…including service e sector pricee inflation

% yoy

2 1

0 1

-1 1 -2 2 96

00 0

Headline inflationn

16 6

0 96

0 02

Core inflaation

Services CPI C

Sou urce: Thomson Re euters Datastream m

Source: Thomson T Reuters Datastream

Moreover, there are ssigns that the housing h marke et is overheatingg while debt le evels have increas sed in the rece ent years. For example, e debt of nonfinanciall corporations to t GDP is 165% while househo old debt to GDP P stands at 85% %. Household ddebt as a share of dispos sable income h as risen substa antially from 17 70% in 2014 too just below 180 0% this year. For F the coming g years, Swedis sh authorities expect e a furtherr rise towards 195% (see the gra aph on the righ ht below). The Swedish S Financial Supervisoory Authority ha as adopted measu ures to restrain these develop pments and to reduce the riskks.

Th he rise in hou use prices is accelerating… …

…and d household debt d is also riising at a bris sk pace

Ind dex

o disposable incom me Percent of

200

800

190

700

180 600 170 500 10

11 1

Real Esstate Price index Sou urce: Thomson Re euters Datastream m

160 10 0

14 15 5 16 Household deebt ratio

Sources: Statistics Sweden n and the Riksbannk Note. Hou useholds' total deb bts as a share of ttheir disposable in ncomes totalled over the past p four quarters.

…lead ding to a less s accommoda ative stance of o the Riksbaank… If we ta ake the state o of the domestic c economy into account and oour expectation ns about global growth and invvestor sentime ent, we judge th hat monetary poolicy in Swede en should becom me less accomm modative. We think t that the Riksbank’s R goall to weaken the e krona to

Sweden Watch - Chan nge in policy y bias soon? ? - 16 Septe ember 2016

create inflationary pre essures served d its purpose and is no longe r necessary. A change in policy will not happen n overnight. We expect inflation to rise fasteer than the Riks sbankâ&#x20AC;&#x2122;s forecasts and the do mestic econom my to remain strong. Thereforre, the Riksban nk will likely change e its forward gu uidance around d the turn of the year. ulting in an ex xpected streng gthening of the krona â&#x20AC;Śresu In the period July 201 13 to July 2015 5, the krona we eakened by 12 % on a trade weighted w has stabilised. Among A G10 cu urrencies, the S Swedish krona is the most basis. Since then it h valued currenccy on the basis of PPP. It is ro oughly 27% unddervalued vers sus the US underv dollar and a 21% unde ervalued versus s the euro. We expect the Sw wedish econom my to continu ue to outperforrm the eurozon ne economy in 2017. In additioon, we expect that inflatio onary pressuress will continue to build resulting in inflation rreaching the 2% % target earlier than forecaste ed by the centrral bank. This should s trigger a change in the e bias of the Riksba ank, signalling a less accomm modative monetary policy aheead. All-in-all th his would be supportive for the kro ona. Therefore, we have raise ed our krona foorecasts (lowerred SEK). Our new year-end forec casts for EUR/SEK for 2016 aand 2017 are 9.4 9 (was 9.5) EUR/S and 8.6 (was 9.0), re espectively. We e have added short s EUR verssus Swedish krrona to our high co onviction list.

Sweden Watch - Chan nge in policy y bias soon? ? - 16 Septe ember 2016

ABN AMRO majorr currency forecasts Change es in red/bold

EUR/U USD USD/JJPY EUR/JJPY GBP/U USD EUR/G GBP USD/C CHF EUR/C CHF AUD/USD AUD EUR/A NZD/U USD EUR/N NZD USD/C CAD EUR/C CAD USD/S SEK EUR/S SEK EUR/N NOK USD/N NOK EUR/D DKK

16-Sep 1.1236 102.59 115.27 1.3194 0.8516 0.9733 1.0936 0.7473 1.5035 0.7266 1.5464 1.3205 1.4837 8.4948 9.5447 9.2758 8.2553 7.4469

Q3 2016 2 1 1.10 100 110 1 1.33 0 0.83 0 0.99 1 1.09 0 0.72 1 1.53 0 0.70 1 1.57 1 1.27 1 1.40 8 8.64 9 9.50 9 9.40 8 8.55 7 7.46

Q4 2016 1.10 103 113 1.33 0.83 1.00 1.10 0.74 1.49 0.70 1.57 1.27 1.40 8.55 9.40 9.25 8.41 7.46

Q1 2017 1.10 103 113 1.34 0.82 1.01 1.11 0.75 1.47 0.70 1.57 1.27 1.40 8.36 9.20 9.00 8.18 7.46

Q2 2 2017 1.10 105 116 1.35 0.81 1.02 1.12 0.75 1.47 0.70 1.57 1.27 1.40 8.18 9.00 9.00 8.18 7.46

Q3 2017 7 1.10 0 108 8 119 9 1.38 8 0.80 0 1.03 3 1.13 3 0.75 5 1.47 7 0.72 2 1.53 3 1.25 5 1.38 8 8.09 9 8.90 0 8.75 5 7.95 5 7.46 6

Q4 2017 1.10 110 121 1.40 0.79 1.04 1.14 0.75 1.47 0.75 1.47 1.20 1.32 7.82 8.60 8.50 7.73 7.46

Q1 2017 6.85 6.88 70.0 1,180 1.42 35.50 33.50 13,500 64.00 3.05 15.25 4.50 27.20 320.00 3.40 18.50 680

Q2 2 2017 6.90 6.93 70.0 1,180 1.42 35.50 33.50 13,500 64.00 3.10 15.50 4.50 27.25 3 320.00 3.50 18.50 680

Q3 2017 7 6.95 5 6.95 5 70.0 0 1,160 0 1.40 0 35.00 0 33.00 0 13,200 0 62.00 0 3.00 0 15.00 0 4.40 0 27.00 0 310.00 0 3.30 0 18.00 0 660 0

Q4 2017 7.00 7.00 69.0 1,150 1.38 34.50 32.50 13,000 58.00 2.90 14.50 4.30 26.50 300.00 3.20 17.50 640

Source: ABN AMRO Grouup Economics

ABN AMRO Emerg ging market currency c Change es in red/bold

USD/C CNY (onshore) USD/C CNH (offshore) USD/IINR USD/K KRW USD/S SGD USD/T THB USD/T TWD USD/IIDR USD/R RUB USD/T TRY USD/Z ZAR EUR/P PLN EUR/C CZK EUR/H HUF USD/B BRL USD/M MXN USD/C CLP

16-Sep 6.67 6.66 67.0 1,127 1.37 34.94 32.40 13,175 65.04 2.97 14.20 4.32 27.02 310.01 3.36 19.30 673

Q3 2016 2 6 6.70 6 6.73 6 68.0 1,,165 1 1.36 35 5.00 32 2.80 13,,100 64 4.00 2 2.95 14 4.75 4 4.40 27 7.10 320 0.00 3 3.30 18 8.50 670

Source: ABN AMRO Grouup Economics

Q4 2016 6.80 6.83 69.0 1,165 1.40 35.00 33.00 13,400 64.00 3.00 15.00 4.45 27.15 320.00 3.35 18.50 670

Sweden W Watch - Chan nge in policy y bias soon? ? - 16 Septe ember 2016

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