Swedish Krona Still Well Below ‘Fair Value’ says SEB's Hammer

An aggressive Riksbank has has been accused of distorting the Krona’s ‘true’ value.

The Swedish Krona (SEK) is likely to strengthen eventually as fundamentals catch up following a period in which extreme central bank manipulation has kept a firm lid on SEK’s scope for appreciation, according to analyst Carl Hammer of Scandinaviska Enskilada Banken (SEB).  

The Riksbank is one of the few central banks which has negative base lending rates, which currently stand at -0.5%, meaning borrowers are actually paid to take out loans - in a topsy turvey twist on the usual relationship in which borrowers have to pay interest on money loaned to them.

The extreme measure has, however, been fairly successful at keeping the SEK cheap, and also helping to stimulate economic recovery (although Q2 GDP was still quite soft).

Low interest rates devalue a currency because they attract less foreign capital flows since investors tend to prefer higher yielding currencies over lower yielding ones.

According to Hammer, SEK’s true value lies at around 9.00 versus the euro (current level 9.4264), but it is unlikely to reach there until the Riksbank back off, an eventuality he sees as unlikely in the short-term:

“The SEK has depreciated more than expected in recent weeks. However, while its current weakness is not justified longer term by economic fundamentals, as long as the Riksbank’s monetary policy objective is to prevent the SEK from appreciating, there is little to suggest a rapid return to ‘fair-value’ (i.e. EUR/SEK below 9.00),” said Hammer.

Nevertheless, the analyst goes on to recommend investors start building ‘long SEK positions’ (a 'long' is a buy trade which makes money if the currency rises) in good time, to take advantage of the eventual up-turn in the currency’s fortunes.

“Still, present levels justify building long SEK positions vs. EUR and USD. Future appreciation depends on when Swedish monetary policy abandons the ECB ‘anchor’.”

Data out on Thursday August 11 showed a higher-than-expected rise of inflation to 1.1%, which whilst not of the magnitude of Norway’s 4.4% was still 0.1% higher than June and well above the 0.8% forecast.

The inflation reading helped the SEK continue higher versus sterling and the euro, as it lessened the chances the Riksbank would have to reduce interest rates even further.

Lloyd’s Commercial Banking’s Jaevon Lolay et al, were more bullish saying the krona’s weakness against the euro looked “overdone.”

Lloyd’s also note how “sensitive” the Riksbank is to inflation, which in view of the rise recorded on Thursday is likely to reduce their concerns and therefore the likelihood of more cuts.

“Various policy officials have reiterated their commitment to deliver more easing. In our view, the bar to further easing remains high. Despite the pace of GDP growth softening in Q2, firmer activity is likely to prevail in the second half of the year. Moreover, long-term inflation expectations remain resilient. In the absence of a marked weakening in the inflation outlook, we believe the Riksbank is likely to refrain from further policy rate cuts.” Said Lolay.

Lloyds end by forecasting a rise in SEK to 9.40 by year end and 9.00 (SEB’s true value estimate) by mid 2017.

From a technical perspective the outlook for GBP/SEK is actually quite complicated.

On the one had the pair is in a short-term down-trend which will probably extend lower, however, on the other momentum as measureed by MACD is failing to confirm the down-trend and is converging sharply with price, signalling the possibility of a rebound higher (GBP strength) in the short-term.

Indeed, the weakness in the pair following the release of Swedish inflation data was short-lived on Thursday and ended with a strong intraday rally which pared a substantial amount of the early losses at the end of the day, and led to a hammer candlestick forming, a pattern indicative of market bottoms.

There is also a possible early double-bottom reversal pattern unfolding, which could signal more upside eventually, if it completes, an outcome which would be GBP positive but SEK negative and therefore in contract with the fundamental consensus, nevertheless, it is still too early to say for sure whether the double bottom is forming yet or it simply looks like a pattern.

If a double bottom does form then a clear neckline is indicated at 11.4500 which would need to be breached to signal a move up to the 11.60s.

Alternatively more downside could be signalled by a break below 10.9000, which would continue the trend down to 10.8000, however, we see this as unlikely given the bullish convergence with MACD, which rather indicates short-term strength and a move back above 11.0000 in coming days, with targets at 11.20, 30 and 40 as the pair rises up to the double bottom's neckline (black horizontal line below).