MNI INTERVIEW: Rate Cut No Krona Help For Riksbank: NIER Head

If the Riksbank were to return its policy rate to negative territory it might not be effective in getting inflation back up to target and weakening the krona, Ylva Heden Westerdahl, Director of Forecasting at Sweden's National Institute of Economic Research, told MNI in an interview.

The recent rebound in the Swedish krona, following a prolonged period of weakness, appears problematic for the central bank with inflation undershooting target and export growth subdued. But Heden Westerdahl, a former research division head at the Riksbank, pointed out that the policy rate does not reliably drive the krona and the currency's level does not reliably determine export strength.

Cutting the repo rate back into negative territory from its current zero percent or adding other stimulus might deliver neither inflation to target nor any real boost to exports.

"My personal take is that I wonder whether it will be effective," Heden Westerdahl commented. "You have structural factors driving down inflation and now you also have weak demand that will hold back inflation. So, I think it will be very difficult for monetary policy to increase inflation, even if the krona would weaken."

UNRULY KRONA

Some policymakers have expressed sympathy with the idea of a future rate cut to combat currency appreciation, with Riksbank board member Martin Floden cited in the July Executive Board minutes as arguing that "it may be appropriate going forward to cut the policy rate, for example if the krona continues to appreciate quickly."

Extensive academic research on interest parity has, however, struggled to find a reliable correlation over policy horizons between rate differentials and currency levels. "Carry trade, all capital flows. It is very, very difficult to see what is driving the krona in the short term. In making a forecast just doing a random walk from where you stand is usually the best forecast - which is just a straight line from where you are," Heden Westerdahl said.

Swedish exporters also often use imported raw materials or other items, undermining any simple assumptions that a softer currency would drive down export prices.

"We had the weaker krona and we thought exports would go up much quicker than they did when we had the upturn of the economy from 2016 until 2019," Heden Westerdahl told MNI. She added that overseas demand was simply not there and the strength of that demand will be the key going forward.

The Riksbank's trade weighted currency index, the KIX, hit 114.652 at the end of July, putting it back at the kind of levels seen in early 2018 having started the year at 120.9248 , where a lower reading indicates an appreciation.

UNCERTAIN RECOVERY

The NIER's latest Economic Tendency Indicator for July, its survey of Swedish business, showed economic activity picking up from its lows but still at historically low levels, with the headline index rising to 83.4 from 75.3 and with confidence indicators for capital and consumer goods producers back to near historic averages.

Compared to the very weak level of exports in the second quarter, when foreign markets were locked down, exports are set to recover as firms that have held back begin to reinvest. "Now they have some pent-up demand, we think, at least for the third and fourth quarter. And usually that will benefit Swedish[d1] exports because we have a lot of investment goods in our export basket," Heden Westerdahl said.

Forward looking indicators are pointing to a continued improvement in Swedish output. "Expectations, expectations of orders and production, they are in positive territory. Those for manufacturing and for the service they are at least now, for July, fairly confident looking forward but who knows if this will last," she cautioned.