Riksbank Formally Ends QE But Pledges Continued Dovish Support For Bond Market

While the Riksbank left its repo rate unchanged at -0.5%, as expected, in its decision this morning, far more interesting was the Riksbank's decision to formally end making new bond purchases, i.e., QE, after almost three years. However, in order to ensure a smooth transition, the Riksbank said the end of QE would take place in the most dovish way possible and the central bank would continue reinvesting maturing bonds and coupons, and also announced that it will bring forward some of the large 2019 redemptions, which it will reinvet in 2018.

“To retain the Riksbank’s presence on the market and attain a relatively even rate of purchase going forward, the reinvestments of these redemptions and coupon payments will begin as early as January 2018 and continue until the middle of 2019,” the bank said. This means the holdings of government bonds “will increase temporarily in 2018 and the beginning of 2019.”

So, while bond purchases will officially end, the bank plans to reinvest as much as 65 billion kronor ($7.8 billion) in returns and front-load investments from maturing debt to avoid any tantrums.

The Riksbank also noted the economic outlook is broadly unchanged since October, seemingly oblivious to the recent sharp plunge in local housing prices, while lifting its inflation forecast owing to energy prices.

With inflation back at the 2 percent target and the economy at full capacity, the Riksbank now faces a tough balancing act as it tries to withdraw stimulus without making the krona too strong. It’s getting some help from the U.S. Federal Reserve, which has already started removing its extraordinary support measures.

And in a lucky twist, as Bloomberg notes, the currency market is also making the Riksbank’s exit easier: the krona has weakened over the past three months on fears Sweden’s housing market is headed for a correction. That, paradoxically, has given the bank more leeway to scale back stimulus.

Observers doubt the central bank will be able to change its dovish colors: Nordea Bank says it will be difficult for the Riksbank to turn too “hawkish,” arguing inflation will slip back below the target in 2018 and 2019. Nordea also warns that “nervousness” over the housing market will hamper a quick retreat from stimulus. It expects the first rate increase in October 2018. “The risk to the forecast is still for a later, rather than sooner, first hike,” said Mikael Sarwe, an analyst at Nordea, in a note.

Looking ahead, the Riksbank kept its forecast for growth next year unchanged at 2.9 percent and lowered its outlook for 2019 to 1.7 percent. Underlying inflation will be 2 percent next year and in 2019. It also raised a warning finger on its outlook and a missive to currency traders: “It has required a great deal of support from monetary policy to bring up inflation and inflation expectations,” the bank said. “Economic activity needs to remain strong for inflation to continue to be close to the target. It is also important that the krona does not appreciate too quickly.”

In other words, those who buy too much, will be crushed.

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Some additional observations from ING's Jonas Goltermann on the Riksbank decision:

  • The main news in the Riksbank's statement today is the decision not to add to its QE programme further, although the decision to front-load reinvestments means that asset purchases will continue in 2018 and the first half of 2019. This means the Riksbank's balance sheet will continue to expand in 2018 and early 2019 providing a very gradual path towards exiting the programme.
  • The policy rate and the forecast for interest rates were both kept unchanged. This means the first rate hike is planned for autumn next year. However, we continue to believe the Riksbank's final decision on when to start to increasing the policy rate depends in large part on how the ECB times its policy normalisation. That will probably only become clear by next summer. If the ECB extends QE beyond the current end-date of September 2018 (which would push its deposit rate hike in mid-2019), the Riksbank is likely to delay its first hike into early 2019 or, perhaps, start with a 10bps hike in late 2018.
  • The other key forecasts in the Riksbank's report are largely unchanged, with near-term inflation slightly higher due to currency and oil prices and slightly lower towards the end of the forecast. The GDP path was very slightly revised (lower in 2019 but higher in 2020). Importantly, the forecast for the KIX currency index continues to indicate a gradual appreciation and the statement maintains the warning that is it "important that the krona does not appreciate too quickly." This suggests the fundamental concern around inflation weakness due to currency strength is unchanged by the recent depreciation of the KIX.

And here are the main take homes from Goldman's Lasse Holboell Nielsen:

1. The Riksbank left the repo rate unchanged at -0.50%. It made no changes to its repo rate path: the first hike is still indicated to be around mid-or Q3 2018. The path continues to indicate an annual pace of hikes of around 35bp-50bp (Exhibit 1).

2. The Riksbank decided to end making new bond purchases. The purchase pace in the past six months has been SEK15bn (having been reduced gradually by SEK15bn per six months since its peak at SEK60bn). Re-investment of maturing bonds and coupons remains ongoing. The Riksbank indicated it will front-run and reinvest some bonds ahead of their redemption to maintain presence in the market and to smooth purchases (in particular, the Riksbank will make purchases ahead of a very large SEK45bn bond redemption in March 2019). This implies that the Riksbank's balance sheet will temporarily rise in 2018 and early 2019.

3. The Riksbank noted that the recovery abroad is ongoing. It noted improving news and revised its forecast of Sweden's trading partners' GDP growth for 2018 up by 0.2pp to 2.7%. This was predominantly driven by positive revisions to the Euro area growth forecast. On domestic activity, the Riksbank's sequential growth path for Swedish GDP was revised slightly down (Exhibit 2). The Riksbank noted that the outlook for the Swedish economy remains strong and is broadly unchanged relative to the October report. Weakness in house prices should weigh on residential investments, but this effect is broadly seen as being countered by improving external demand.

4. The Riksbank noted that inflation had surprised somewhat to the upside in November. As a result, the forecast for CPIF inflation was lifted around 0.2pp through most of 2018. The revision to CPIF excluding energy was more modest. The Riksbank left its wage forecast unchanged.

5. The Riksbank remains cautious on the currency, despite recent weakness (which is around 3% weaker than projected by the Riksbank in October). It still notes that owing to inflation concerns, the Krona should not appreciate too quickly, and that this could happen if the Riksbank's policy differed too far from that of other central banks. The Riksbank's expected Krona path was revised somewhat weaker in the near term reflecting the recent surprises, but with the long-term forecast left broadly unchanged (Exhibit 4).

6. The Riksbank continues to express concern regarding financial stability risks related to high household debt, but that macro-prudential policy (and other government polices) should deal with this issue. On the recent decline in house prices, the Riksbank so far seems to take a benign view on this, with the price decline being seen as temporary and moderate. Lower house prices also help reduce the increase in household debt. The main effect is viewed as implying some weakening in residential investments but without broader spill-over effects and with no major consequences for inflation.

7. The board was split on the decision to reinvest bonds early, with Flodén and Ohlsson dissenting (preferring a later decision on this issue). Today's announcements by the Riksbank are closely in line with our expectations. We currently view the Riksbank as being in an 'absorbing state', showing little data sensitivity. We expect this to change over time, possibly quickly at some point. We maintain our forecast of a hike in Q2 (base case) or Q3 next year.

Exhibit 1: Riksbank leaves its repo rate path unchanged in December

Exhibit 2: The Riksbank revises growth down slightly

Exhibit 3: The Riksbank's near-term inflation forecast lifted in December

Exhibit 4: The Riksbank marks to market its Krona forecast