Thursday, October 11, 2007

Swedish-EMU Interest Parity Again?

Consumer price Inflation rose significantly in Sweden in September. The EU-harmonized index rose from 1.2% in August to 1.6% in September, the national index from 1.8% to 2.2% and the Riksbank's version of core inflation (excluding interest rates, taxes and subsidies, rather than food and energy) rose from 0.7% to 1.0%.

This was more than most market participants had expected and so the Swedish krona rose to a new post-1992 high against the U.S. dollar and it also rose against the euro and most other currencies. It may seem like a paradox that the news that the domestic value of the krona fell would cause an increase in the foreign exchange value of it, but the explanation is of course the expectation that this will cause the Riksbank to raise interest rates.

And that looks increasingly likely, perhaps as soon as the next meeting. With ECB rates staying unchanged indefinitly, this would mean that for the first time since 2005, there would be parity between Swedish and Euro area interest rates.

And the Riksbank looks a lot more likely than the ECB to raise more after that, with Swedish growth staying strong due to a combination of rapid credit- and money supply expansion and supply boosting tax and spending cuts from Sweden's centre-right government. At the same time, soaring food and energy prices along with high wage increases pushed through by unions earlier this year means that further increases in inflation looks likely. So, it seems likely that Swedish short-term interest rates will be higher than in the euro area in just a few months.

All of this is of course very bullish for the Swedish krona, who will likely continue to rise against both the euro and the U.S. dollar.


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