(Bloomberg) -- Sweden’s central bank just handed the krona a lifeline. The question now is whether the rally has legs.

After months trying to talk up the local currency, the Riksbank is stepping into the market, selling dollars and euros to hedge its reserves against an appreciation of the krona. 

Traders rushed to front-run the central bank’s sales, boosting the currency from a record low against the euro earlier this month to the brink of its best quarter in nearly three years.

For ING Bank NV and Societe Generale SA, the Riksbank’s program will put a floor under the krona’s slide in the coming months. The currency gained from near 12 to about 11.50 per euro in a couple of weeks and Nordea Bank Abp said it’s now close to its fair value at 11.40 per euro. 

“The krona is cheap, there’s no getting away from it,” SocGen strategist Kit Juckes said. “It’s early to get short the euro versus the krona, but I don’t want it to have come from 12 to 11 before I realize that I’ve missed the bus.”

Investors have been dumping the krona since late 2021, cleaving away about a fifth of its value, after the Riksbank came late to the post-Covid inflation fight.  

Policy makers eventually hoisted rates to their highest since the global financial crisis, putting the economy on the brink of recession and crippling the housing market as Swedes struggle to pay soaring mortgage bills. 

Now, traders are preparing to scrutinize upcoming data on krona purchases to understand how aggressively the central bank is buying and whether it plans to front-load operations in order to seize on the still-weak rate. 

The Riksbank has said it will sell $8 billion and €2 billion ($2.1 billion) — a quarter of its reserves — under the hedging program over the next four to six months. 

“If they are selling more dollars and euros against the krona at higher dollar-krona and euro-krona levels, then they’re helping build a floor for those pairs,” said Francesco Pesole, a currency strategist at ING. “Risk sentiment still needs to improve to drive the krona higher, but that can cap the downside risks.”

Read More: Riksbank Governor Says Investors Could Emulate Krona Hedging

On Friday, Riksbank Deputy Governor Martin Floden said that the krona was “still clearly undervalued” despite this week’s gains. The currency was up 3% this week to 11.50 per the euro, outperforming all its Group-of-10 peers.

For Morgan Stanley, the Riksbank is amplifying the message that the krona’s losses are overdone by “putting its money where its mouth is.”

Yet the bank’s strategist’s including David Adams wrote in a note that the hedging operations are unlikely to give much lasting support to the currency, citing issues including their small size.

Choppy Trading

The krona is famously volatile and vulnerable to global risk appetite. So any recovery is likely to be choppy, especially if the economy shows signs of deeper weakness.

What Bloomberg Economists Say...

“We expect the economy to contract by 0.8% annually in 2023. That will likely make Sweden the worst economic performer among major European economies this year.”

Selva Bahar Baziki, Turkey and Sweden economist for Bloomberg Economics

Danske Bank A/S says it would sell the krona if it continues to climb against the euro, while Nomura Holdings Inc. says the currency’s gains will be temporary. 

“The Riksbank is buying time to try to get to a better place where the market believes the fundamental story and starts to buy krona,” said Brad Bechtel, global head of FX at Jefferies in New York. “There’s no guarantee, because growth is not looking any better in the near future.”

--With assistance from Vassilis Karamanis and Niclas Rolander.

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