- The Riksbank sells government bonds.
- The supply – or the number of bonds available on the market – increases.
- When the supply increases, the buyers demand a higher yield/interest. Therefore, the price must drop.
- The Riksbank hopes that higher interest rates and increased activity on the market will attract more foreign investors.
- When foreign investors want to buy Swedish government bonds, they need Swedish kronor.
- This increases the demand for SEK, which means that the krona is strengthened against other currencies.
Put simply, issuing bonds is a way for the government to borrow money, against a promise to pay a certain interest on the loan. Typical investors in these bonds are pension funds, banks, and insurance companies. The bonds can then be resold on the secondary market, if the investors wish to do so.
“There are several reasons for investing in government bonds. For one, these are seen as very safe, with the state being the counterparty. Furthermore, there are legal requirements on risk level that for example pension funds must adhere to, which adds to the demand. In general, it can be said that those who invest in Swedish government bonds tend to hold onto them tightly. The turnover on the second-hand market is not that high”, Amanda Sundström says.
Enter the Riksbank. Sweden's central bank is not allowed to buy bonds directly from the government. It can, however, take part in the second-hand market. What happens with the Riksbank now starting to sell off its previously purchased government bonds is that the increased supply causes bond prices to fall.
Falling bond prices mean that investors' returns increase, as the repayment and interest – which the holder receives from the government when the bond matures – are based on the original price. Put differently, a second-hand buyer who keeps the bond until it matures collects as many kronor as the first-hand buyer would have received, for a smaller investment.
“When there are more bonds on the market, buyers demand a higher yield, or interest rate, to buy them. A higher interest rate requires a lower price, so the price of the bonds falls”, says Amanda Sundström.
Does the increase in interest rates on the bond market risk spilling over to mortgage interest rates?
“The Riksbank's sale of government bonds does mean a tighter monetary policy, but if it has any effect at all on mortgage rates, it will be marginal. The key interest rate is much more important in this respect.”
What about the Swedish krona?
According to Amanda Sundström, the main effect that the Riksbank hopes for through its sale of government bonds is to strengthen the Swedish krona.
“As mentioned earlier, the secondary market for Swedish government bonds isn’t very active. In addition, the interest rates are relatively low. If you add that the krona and other small currencies often take a bigger hit in times of global uncertainty, it gives a decent picture of why the demand for Swedish government bonds has been quite lukewarm among foreign investors.”
Amanda continues: “The Riksbank is hoping that the higher interest rate and increased turnover on the market is going to attract more foreign investors, which in turn will create an increased demand for Swedish kronor.”
And an increased demand strengthens the krona – but when can we see the results?
“We need to remember that this is a structural measure, to create a more liquid market, and not something that will have a quick effect. But all efforts that attract foreign capital – whether it is to buy government bonds or invest in Swedish infrastructure – can contribute to strengthening the krona. Therefore, our view is that the Riksbank's measures may have certain long-term significance”, Amanda concludes.