Riksbank to deal with catch 22 situations of currency depreciation, inflation and wage negotiation

Currency pressures

The generally negative tone of risk for SEK's traditional status as a risk proxy. The apparent reversal of SEK's relationship with general risk appetite is largely a consequence of the fact it trades as a satellite of EUR, which has itself assumed the qualities of a safe-haven currency (temporarily in our view).

Going forward, the dangers for SEK are that either markets turn risk-seeking, reversing gains, or much more severely riskoff, calling into question EUR's (and with it SEK's) status as a safe-haven. Moreover, EUR/SEK is now close to the levels (9.20-9.30) that have caused the Riksbank to openly talk the currency down and to ease domestic policy to reverse currency strength.

In the last Riksbank policy announcement on 3rd September, the central bank kept the main policy rate unchanged (-0.35%) and did not add to its QE programme (SEK135bn) and its forward guidance suggested a small risk of a further cut. The Riksbank's heightened sensitivity to headline inflation heading into next year's wage negotiations (see below) and recent SEK strength suggest this risk is more likely to rise than fall from current market pricing. We expect EUR/SEK to base around current levels (9.35) and push back to the top of the recent range around 9.60.

Headline Inflation and wage negotiation:

As 2016 comes into focus, so will the next major wage round scheduled next year. Agreements covering around 3 million employees (63% of labour force) in the private and public sector will expire.

Unless the Riksbank manages to engineer a material rise in headline inflation (current consensus forecast is just 1.0% in early-2016), the risk is that wage negations are benchmarked to very low inflation expectations and employees lock in very weak wage growth for three years.

This in turn will put downward pressure on future inflation, making the task of battling low inflation even harder for the Riksbank. Assuming core inflation continues its trend acceleration, we see EUR/SEK drifting lower in the latter half of the next year once higher prices become more entrenched and the Riksbank can start to gradually raise interest rates.