Think the RBA will lift rates on Melbourne Cup day? Don't bet your house on it 
Inflation: I've been analysing the Bank of England's forecast over the past two years – here's how they got it wrong 
Will the RBA raise rates again? Unless prices surge over summer, it's looking less likely 
If central banks don't start cutting them soon, it could actually increase inflation 
The chart above shows, how the relationship between USD/SEK and 2-year yield spread has unfolded since 2012.
- The Sveriges Riksbank (SRB) began reducing interest rates (repo rates) in the aftermath of the ‘Great Recession’ of 2008/09. The interest rates declined steadily from 475 basis points in 2008 to just 25 basis points in 2009.
- The rate was increased to 200 basis points in 2011 as the impact of the ‘Great Recession’ was less severe.
- However, the interest rates were reduced again in the aftermath of Eurozone debt crisis. Since the end 2011, SRB reduced rates from 200 basis points to zero in 2014 and was further lowered to -50 basis points in 2016 and it remained at the level.
- In addition to that, SRB introduced asset purchase program.
- It can be seen from the chart as while SRB started reducing rates again between 2011 and 2015 and maintained dovish tone, and the US Federal reserve indicated, and began to wind up its asset purchases, the 2-year yield spread widened in favor of the dollar by more than 200 basis points and the exchange rate declined from 6.4 per dollar to 8.6 per dollar.
- However, since the beginning of this year, there have been speculations in the market that the SRB would soon follow other central banks in the region, namely the Czech National Bank (CNB) that increased interest rates by 20 basis points in August this year. The speculation is being fuelled by higher inflation that reached a five-year high of 2.2 percent in August.
- A strong divergence is visible even with the naked eye. So far this year, the yield spread has widened by almost 9 basis points in favor of the dollar, while Swedish Krona has strengthened by almost 1000 pips.
- So, the exchange rate has moved much faster than the spread, which is not an unusual phenomenon. However, such divergence will not sustain in the medium term. So, expect the spread to narrow against the dollar and or the exchange rate to move lower in favor of the dollar.
Hence, we expect hawkish commentaries from SRB, in absence of which the exchange rate could decline favoring the dollar. The spread is currently at 197 basis points and the exchange rate is at 8.1 per dollar.
With central banks changing their monetary policy outlooks, we highly recommend regular following of the yield spread.
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