MNI INTERVIEW: Not Clear Krona Undervalued - Riksbank Head

Sweden’s central bank no longer has a strong view on the future direction of the krona, whose recent appreciation against the euro and the dollar is already putting a brake on inflation, Governor Erik Thedeen told MNI.

Speaking after the Riksbank held its policy rate at 1.75%, Thedeen said fund repatriation and increased hedging by portfolio managers may have been factors in the krona's rise amid broad dollar weakness but it was unclear how much further these effects had to run.

Previously, when the currency was more than 10% weaker against the euro than now, the Riksbank had "a strong, strong view," that it was undervalued, he noted.

"At that time, some people said that we never know anything about currencies. And on a day-to-day basis that's true, but I think we had the courage to say 'this is undervalued, [it] should strengthen', and that that should also help us when it comes to the inflation target. Okay, that has now happened, of course, part due to the dollar move, but also the krona has strengthened in itself. So that's been welcome. At this this level we don't have a strong view that it's undervalued or it's overvalued.”

The speed and strength of the pass through to inflation from an earlier period of krona depreciation surprised the Riksbank, he said, and similarly swift effects may now occur in the opposite direction.

"When inflation was high … the inflationary effect of the krona down move was more pronounced than we thought. And maybe now there's some indication that, maybe, the effects on the deflationary side are also slightly more pronounced. Will that last? Well, very uncertain," Thedeen said.

Imported goods have been more expensive in Sweden than in the eurozone, he noted.

"So now when the krona strengthened there was some room to move down here. And maybe that's partly the explanation why the feed through is a little bit stronger." (See MNI INTERVIEW: Riksbank's Thedeen Sees Policy Rate Stimulative)

REPATRIATION AND HEDGING

Recent reports of Swedish pension fund Alecta moving out of U.S. Treasuries have re-focused attention on the potential for repatriation flows, though Thedeen noted that the extent to which fund managers hedge dollar exposure is also key. 

"There's not super good data here ... but I think it's clear that if you look at mutual funds and things like that, it seems that people are moving out from pure U.S. funds more into, let's say, global funds, which is little bit of a paradox, because global funds are  … 70% U.S. equity, or something, but also into European and Swedish [funds]," Thedeen said. 

"More importantly, I think, is the hedge ratio of some of the portfolios ... There is very limited data, but I expect ... that on the investment committees or in the boardrooms, this will probably be a discussion - 'should we increasingly hedge our U.S. exposure or not?' Maybe partly, we're seeing some of that.”

Typically funds hedged bond rather than equity exposure, but dollar weakness may have prompted a re-think, as, even if Swedish retail investor funds saw sharp U.S. equity rises, "in krona terms they lost money, and that is, of course, a wakeup call," he said.

"The question, I guess, is ‘is there more room to go? Is there even more hedging to do?’ ... in our previous forecast, we didn't foresee a sharp [krona] strengthening from these levels. We have to come back to that when we do the new forecast," he said, referring to the next forecast round in March.

The Swedish government plans a temporary cut in VAT on food from 12% to 6% from April, but while the Riksbank cited the risk this would lower inflation expectations, Thedeen downplayed this despite the central bank’s current forecast for headline inflation to drop below 1%.

Expectations were "fairly stable when inflation picked up at 10% and if they will drop down to our forecast, even below 1% at a certain stage, would that make five-year expectations go down? That's not our assumption," he said.

BALANCE SHEET

The Riksbank is also pushing to lower central bank liquidity and to stimulate the interbank market. (See MNI INTERVIEW: Higher Bar To Future Riksbank QE - Thedeen)

"What's important now is that banks start to even out the liquidity between them, because they can't rely on this abundant kind of liquidity or reserves. I think we see some indication that that's starting to happening. It's not perfect. We will continue to push for that," he said.

A decision on its liquidity and lending facilities "will probably come the first half year. That would be my expectation, but it was also depend on what's happening in the market."