Speculators are turning their attention to the Swedish crown, expecting it to weaken as Sweden reacts to the threat of a widening currency war in Europe. Sweden's Riksbank might open fire as early as next week by cutting interest rates to less than zero and setting the stage for quantitative easing. But if those efforts fall short, analysts say, the central bank may need to intervene directly to weaken the crown.
The European Central Bank's 1.1 trillion-euro quantitative easing programme, announced last month, pushed the euro lower against a host of European currencies. In response, the Swiss National Bank abandoned its cap on the value of the franc and Denmark's central bank intervened in record amounts. "The Riksbank should intervene and talk the crown down like the Swiss and the Danes. That will have a much bigger impact on the currency than quantitative easing or rate cuts," said Carl Hammer, chief currency strategist at SEB, a leading Nordic bank.
However, the Riksbank has not intervened in the currency market for more than a decade, so it is unlikely to do so immediately. In the options market, investors are betting on a sustained period of crown weakness. One-month euro/Swedish crown risk reversals - a gauge of demand for options on a currency rising or falling - show an increasing bias for crown weakness against the euro. The pricing partly reflects expectations the central bank will begin a QE programnme of its own. Central bank asset purchases usually weaken a currency by increasing its supply, but the Riksbank is expected to buy only 15 billion to 20 billion crowns (232.75 million euros) a month.
That will be dwarfed by the European Central Bank's 60 billion euros a month, so it is unlikely to be a game changer. Indeed, a Reuters poll released on Wednesday forecast the crown would rise to 9.36 crowns per euro in three months from 9.44 now, and to 9.33 in six months. Unlike the Swiss and the Danes, Sweden's central bank has a relaxed attitude towards its currency. The last time Sweden intervened was in 2001, when it was trying to support the crown.
"We would not rule out intervention in the FX market later on, but that is probably going to be the last resort," said Susanne Galler, a currency strategist at Jefferies. Things have changed since 2001, though. At the height of the euro zone crisis in 2012, investors piled into the crown, thanks to Sweden's sound public finances and high credit ratings. As the crisis ebbed and growth in Sweden weakened, the crown fell. But after the ECB announced its QE programme on January 22, the crown reached a two-month high against the euro. The gains worsened the threat of deflation and bolstered the view that the Riksbank needs to act fast.
The crown's response to unconventional measures will be key to Riksbank efforts to lift inflation back towards its target of 2 percent from -0.3 percent now and whether it finally resorts to intervention. "If the crown does not depreciate significantly, then QE would probably provide only limited stimulus," Tina Mortensen, economist at Citi. "And against the likely background of QE and/or rate cuts from the ECB, Danish central bank, Swiss National Bank, Norges Bank and BOJ, a decision to start QE in Sweden may have relatively little effect on the exchange rate."
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