Krona suffers after Riksbank rate hike

The Swedish krona slumped on Thursday morning after the Riksbank said it expects to increase interest rates more slowly than markets have been forecasting.

The krona fell to the weakest levels in three and a half months against the euro, to about 9.22 kronor per euro from 9.14 kronor. It also weakened against the dollar, which rose to 7.02 kronor from 6.95 kronor.

Sweden’s central bank, or Riksbank, raised interest rates this morning, as expected, but said that it expects rates to rise by another quarter point this year before pausing. Financial markets were expecting another two rate hikes.

“This is a surprisingly relaxed view and would suggest the repo rate ending the year at 3.50 percent” from 3.25 percent currently, said Henrik Gullberg at Calyon.

The Riksbank said in its statement this morning that the reason it “does not consider it necessary to raise the repo rate more, despite strong growth, is that inflation is subdued by a number of factors, including a rapid increase in the labour supply.”

It forecasts inflation to only come close to the 2.0 percent target towards the end of 2008. Furthermore, “GDP growth in Sweden will slow down during the period 2007-2009, when the international business cycle enters a calmer phase and productivity growth declines,” the central bank said.

Calyon’s Gullberg is a bit more hawkish than the Riksbank, however, saying that strong growth in the fourth quarter shows no signs of letting up.

He points to demand for labour hovering around record highs, which should drive wage growth somewhat, while money supply growth is “rampant” at 15-20 pct.

He expects these factors to become increasingly reflected in the Riksbank’s forecasts, and for this to push the bank to hike not once but twice this year.

However, the krona has been weighed somewhat in recent years by carry trades — when investors borrow from countries with relatively low interest rates, like Sweden, and invest in higher-yielding economies — and this is likely to keep the krona from strengthening much.

“As long as spot inflation continues to come in on the low side of expectations the Riksbank is likely to continue to hike rates very gradually, limiting the FX market’s appetite for the krona,” said Gullberg.