MNI ANALYSIS: Krona Depreciation Not Likely To Sway Riksbank

By David Robinson

     LONDON (MNI) - Riksbank policymakers will have a high degree of tolerance

to the krona's headline grabbing fall against the euro in recent days, with the

currency pretty robust on its effective-exchange rate index and core inflation

still weak.

     The Riksbank Executive Board's policy decision and updated Monetary Policy

Report will be unveiled Thursday, with no change in policy anticipated. On July

4, when the board made its previous decision, the krona stood at 117.857 on the

KIX, the central bank's preferred effective index, and on Tuesday it stood at

120.154, a 1.9% rise.

     Swedish krona's eye-catching fall in recent days against the euro, with the

single currency hitting its highest level since 2009, is not going to be enough

to trigger concerns of a marked inflation overshoot.

     The Riksbank's in-house research highlights the complexities of estimating

the likely pass through from krona movements to domestic inflation. Sweden's

economy is exceptionally open and trade driven, with the share of imports and

exports averaging 82% over the past two decades compared to 54% for the UK and

70% for Norway.

     One reason cited for the recent decline in the krona against the euro is

fears over trade wars and softer euro area demand. 

     A Riskbank research paper by Vesna Corbo and Paolo Di Casolo on exchange

rate pass through found a negative correlation with domestic prices when the

economy is hit by domestic or foreign demand shocks. A 1%

depreciation/appreciation in the exchange rate due to a change in demand is

accompanied by a decrease/increase in prices, rather than the reverse effect

implied by traditional models. 

     --DEMAND EFFECTS

     The Riksbank work cited similar research by Kristin Forbes when she was at

the Bank of England, which stressed that what matters for inflation is the

source of exchange rate moves and that the impact of demand effects can dwarf

currency ones.

     At the July meeting the more dovish members of the six person Executive

Board highlighted their concerns about, in Deputy Governor Per Jansson's words,

the signs that "underlying inflation is showing signs of weakness and is low."

     Governor Stefan Ingves highlighted how Sweden's inflation outlook was

intermingled with those of its trading partners. 

     "With today's goods and services markets, it is difficult to believe that

Sweden could have a rate of inflation that, on a more permanent basis, clearly

exceeds that of other countries," he said.

     The September meeting will allow the Board to reappraise its guidance that

"slow repo rate rises will be initiated towards the end of the year," with

members even split between those backing or tilting to earlier tightening or

sympathetic to more extended delay.

     The currency movement may well not alter the balance, with Ingves having

the casting if by the end of the year the committee splits down the middle.

     A survey by banking group SEK of market participants found just over half

expected the Executive Board to look its key policy message unchanged with the

remainder expecting it to be tweaked by some recognition of greater uncertainty

over the future direction of policy.

     A clearly hawkish response to currency weakness is not on the horizon.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com