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World's Oldest Central Bank to Exit Negative Rate Policy First

World's Oldest Central Bank to Exit Negative Rate Policy First

2019-12-16 05:00:00
Dimitri Zabelin, Junior Currency Analyst

Swedish Krona, Norwegian Krone, Riksbank, Norges Bank – TALKING POINTS

  • Riksbank pioneering central bank phenomenon: climbing out of negative rates
  • The Swedish Krona could rise on Riksbank rate hike but may fall on the outlook
  • Norwegian Krone may oscillate between Norges Bank rate decision, trade risks
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The Swedish Krona along with policymakers around the world will be closely watching the upcoming rate decision from the oldest central bank in the world: the Riksbank. Scandinavian monetary authorities are set to end their five-year journey in negative interest rate territory and may be viewed as a template for institutions seeking to do the same in the future.

Riksbank Rate Decision: Why it Matters for Global Policymakers

Following the 2008 financial crash, the Riksbank embarked on an easing cycle and eventually drove interest rates into negative territory for the first time in the central bank’s history. However, the ascension of the benchmark from the proverbial abyss is a key insight for global policymakers who wonder what a recovery from negative interest rates looks like.

In this regard, the magnitude of the upcoming rate decision cannot be underestimated since it could become a source of abundant joy or market-wide panic. How Sweden’s financial system endures tightened credit conditions after an unprecedented amount of time at an ultra-loose setting could be a template for how larger economies – like the Eurozone – cope with a similar struggle.

While the Swedish economy may have been saved by expansionary monetary measures, the specter of its own policies is coming back to haunt it. Amid the low-interest rate environment, Swedes began to incur large sums of debt since the cost of borrowing so was low. More specifically, they began to take on mortgages which have led to an explosion in the Swedish housing market.

Chart showing UBS Real Estate Bubble Index

Note: Below -1.5: Depressed Between -1.5 and -0.5: Undervalued Between -0.5 and 0.5: Fair-Valued Between 0.5 and 1.5: Overvalued Above 1.5: Bubble Risk.

The growing concern now is debt-burdened Swedes – with an average debt-to-income ratio of over 330 percent – have become sensitive to interest rate adjustments. More precisely, their ability to service their debt may become compromised if interest payments on their various loans exceeds their income. The result is a possible onslaught of defaults that creates an inter-bank contagion spreads throughout the Baltic states.

As the Riksbank noted in their bi-annual Global Financial Stability Report:

“Expectations of very low interest rates in the coming years…can lead to an increase in risk-taking to assets being overvalued and to indebtedness increasing in an unsustainable manner. Several participants have also turned to riskier and more illiquid assets to obtain higher returns. Were economic developments to become significantly weaker than expected, it could expose vulnerabilities that have built up in the financial system.

Both households and banks have large exposures to the housing market, which means that a large fall in prices could have consequences for macroeconomic and financial stability in Sweden. The Swedish banking system[‘s] size, concentration, interconnectedness, limited capital levels and, in some respects, low resilience to liquidity risks [are sources of vulnerability]”. – Riksbank Financial Stability Report

Furthermore, the vulnerability in Sweden’s debt market is amplified by the fact that Sweden is an outward-facing economy with “a financial system that is dependent on international financial markets”. Multiple factors including trade wars and a disorderly Brexit or a combination of elements could trigger a multi-iterated financial contagion of the country’s debt and bring the Swedish economy to its knees – and the Krona with it.

Norges Bank Rate Decision: What is the Outlook?

Officials at the Norges Bank (NB) are expected to vote to keep interest rates at 1.50 percent after raising rates three times this year, effectively doubling the cost of borrowing. The downside shift in implied policy rates from a month ago show that markets are expecting expansionary policy in the near term, while the 2- and 3-year tenors are showing a more hawkish outlook.

Looking ahead, traders will continue to monitor fundamental developments like the US-China trade war and its impact on crude oil prices. The petroleum-linked Norwegian Krone is particularly susceptible to oscillations in global sentiment as Norway primarily relies on oil revenue to sustain its economy. Strong growth from abroad is crucial to sustain for the Scandinavian country’s export-driven economy.

US-China Trade War

For now, there has a surface-level improvement in US-China trade talks as US President Donald Trump agreed to not impose the December tariff hike. Washington has agreed to tariff rollbacks in phases and Beijing has agreed that the Asian giant will purchase US agricultural goods and will almost double the latter’s exports in two years. However, upside momentum is somewhat limited as the prospect of reaching “phase 2” is uncertain.

US GDP Data on Deck, Critical PCE Statistics

US GDP data is expected to show that the world’s largest economy grew 2.1 percent on an annualized, quarter-on quarter basis. Personal consumption is expected to remain unchanged at 2.9 percent, and year-on-year Core PCE is expected to have shrunk to 1.5 percent, down from the prior 1.6 percent print. If the data outperforms and cools recession fears, it may boost risk appetite and push the sentiment-linked NOK and SEK higher.

Eurozone Growth Data

Critical Eurozone PMI data may elicit some volatility in Euro-Nordic crosses, though price oscillations may be curbed by traders waiting for the Riksbank rate decision later in the week. Other key data to watch out for in the week will include CPI and consumer confidence data. This follows last week’s ECB rate decision and first press briefing by the newly-appointed President Christine Lagarde.

World's Oldest Central Bank to Exit Negative Rate Policy First


--- Written by Dimitri Zabelin, Jr Currency Analyst for DailyFX.com

To contact Dimitri, use the comments section below or @ZabelinDimitrion Twitter

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