Swedish krona volatility and negative interest rate policy

Sweden is one of 28 European Union member nations, with intra-EU trade accounting for 59% of Sweden’s exports and 71% of Sweden’s imports. Despite the significant levels of intra-EU trade and the signing of the Treaty of Accession in 1994, Sweden has not joined the Eurozone. Maintaining the Swedish krona as its currency has allowed Sweden’s central bank, Sveriges Riksbank, to independently set its monetary policy to achieve an inflation target of two percent. Market pressures arising from the financial crisis however have caused the Sveriges Riksbank to frequently miss its inflation target. On February 12, 2015 to avoid deflation, the Sveriges Riksbank reduced its short-term interest rate below zero, a policy position that had been adopted by the European Central Bank and others during 2014.

This study examines the impact that Sweden’s negative interest rate policy has on bilateral exchange rate volatility with its major trading partners’ currencies - the Euro, Danish krone, Norwegian krone, United States (U.S.) dollar, and the (United Kingdom) U.K. Pound - with a focus on the negative interest rate policy. Germany, Norway, Finland, the Netherlands, Belgium, and France use the euro, which follows a floating exchange rate system. Denmark maintains a European Exchange Rate Mechanism (ERM II) with the Euro countries. Norway, the U.K., and the U.S. follow a floating exchange rate regime.

Using daily data gathered from the central banks of each country and the Organization for Economic Cooperation and Development (OECD) from January 4, 1999 through March 31, 2018, this study uses a generalized autoregressive conditional heteroskedasticity (GARCH) model to estimate the exchange rate volatility and the influence interest rate policy has on the volatility. The study results find volatility clustering and heteroskedasticity in the daily bilateral exchange rates over the period January 4, 1999 through March 31, 2018. GARCH and eGARCH results find evidence that interest rate policy significantly influences daily bilateral exchange rate volatility and that negative interest rate period is significantly different from the period of positive interest rate policy.