The Swedish krona lost more than eight percent against the euro this year. That looks a touch overdone.
It has been an unusual summer, for those habitually visiting Sweden at this time of the year. On the one hand, temperatures rose to almost Mediterranean levels. On the other hand, the currency continued to weaken – something (not so long ago) also quite familiar around the Mediterranean. While the krona had already depreciated by around ten percent against the euro between 2014 and 2017, this year alone it fell by another eight percent. As the leaves start to fall, however, the krona might be in for a recovery.
Currency weakness partly reflected weaker-than-expected inflation figures. This, in turn, led market participants to revise their expectation of an interest-rate hike in 2018, putting pressure on the krona.
More recently, political concerns added to the currency's woes. Like many other countries in Europe and elsewhere, Sweden is witnessing an increase in right-wing populism. In the run-up to elections to the Swedish parliament, the issue of migration has been discussed loudly and controversially. The "Sweden Democrats" (SD)[1] party has been especially outspoken – even calling into question whether Sweden should remain in the European Union by hinting that a referendum on the topic might make sense.
In this respect, we interpret the most recent currency movements as an increase in the political risk premium. But we consider the chances of a referendum as desired by the SD to be minimal; after the election, the somewhat heated mood should cool down again. In addition, we note that the central bank's inflation target (harmonized index of consumer prices) of two percent has already been reached in May, and exceeded it in the following two months for which data is currently available. Assuming inflation does not recede again, that factor no longer stands in the way of an interest-rate rise. Once political risk begins to fade the recovery might be swift. According to Andreas Burhoi, currency expert at DWS, the Swedish krona could then move back towards 9.50 per euro.
Sources: Bloomberg Finance L.P., Deutsche Asset Management Investment GmbH as of 8/30/18
