Business

Do diverging central banks in peripheral Europe provide an opportunity?

In Sweden, inflation has been exceeding the Riksbank’s 2 per cent target for the past five months
In Sweden, inflation has been exceeding the Riksbank’s 2 per cent target for the past five months In Sweden, inflation has been exceeding the Riksbank’s 2 per cent target for the past five months

"Buy not on optimism, but on arithmetic." - Benjamin Graham

A lot of investor attention is directed towards ECB policy changes, as its asset purchase program will conclude later this year, and guidance on interest rates will increasingly be the center of attention. Yet, there are neighboring economies closely linked to the euro zone that may be at different stages of the policy cycle, while receiving less investor attention.

:: Swedish Riksbank ready for lift off

At the monetary policy meeting held on 23 October, the Riksbank’s executive board decided to keep the policy rate at -0.5 per cent, but indicated that it will likely be raised by 0.25 per cent either in December or February. The meeting minutes revealed that two out of the six board members, including the deputy governor, had reservations against keeping the policy rate unchanged and were actually in favour of an increase to -0.25 per cent. Financial markets have now started to price in the start of a very gradual path towards tightening monetary policy for the Swedish economy.

In Sweden, inflation has been exceeding the central bank’s 2 per cent target for the past five months, and currently stands at 2.4 per cent. This should give the Riksbank some comfort to start moving away from negative interest rates – a potential tailwind for the Swedish Krona (SEK).

::The Swiss National Bank (SNB) not quite yet

Switzerland has experienced almost a decade of deflation, as the Swiss Franc (CHF) appreciated significantly from inflows as investors seek shelter in safe-haven assets. Inflation returned to positive territory early last year, but has since been below 1 per cent. So the SNB has no incentive to start raising policy rates anytime soon, and will likely be one of the latest among the developed world central banks to start tightening monetary policy. As headlines risks concerning the Italian budget negotiations resulted in investors favouring safe havens again, CHF appreciated more than 5 per cent so far this year against the euro, extending its overvaluation even further. Given the SNB’s reputation of active exchange rate intervention, it is more likely that the SNB will start using rhetoric at some point in an attempt to limit the extent and pace of appreciation. In a recent speech, Governing Board Member Andrea Maechler hinted that it was “too soon to contemplate (raising interest rates) … as the Swiss franc remains highly valued and the situation on the foreign exchange market is still fragile”.

::SEK/CHF

Although SEK/CHF gained about 7 per cent throughout 2017, it has given back about 8 per cent this year. On most measures SEK is significantly undervalued, in contrast to an overvalued CHF. Also, we’ve observed that exchange rates have a tendency to somewhat mean-revert over multi-year periods. Currently, SEK/CHF is close to the lowest level in ten years; mean-reversion would imply some upward drift for the currency pair over time.

Given the absence of a cost to hold the currency exposure (‘carry’), is it time to start owning some Swedish krona versus Swiss francs at a point where central banks are likely to move at different speeds.

:: Jonathan Sloan is a director at Barclays Wealth & Investment NI