Norwegian Krone: Norges Bank Steps Up to Bat

- NOK underperforms ahead of Norges Bank decision
- Analysts, market eye no change & no new signals for NOK
- But inflation, NOK lethargy could augur 'hawkish' surprise


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The Norwegian Krone was again an underperformer among major currencies ahead of Thursday’s monetary policy decision from the Norges Bank, which could be more of an upside risk to the oil-linked currency than is commonly appreciated.

The Krone ceded ground to all of its nine largest rivals on Wednesday, helping to cement it in place as the second worst performing major currency of the recent week.

The Krone’s declines have seen the oil-linked currency relinquish its crown as the top performer of 2021 over the last week, due in part to outperformance by the Canadian Dollar, and lifted the Pound-to-Krone rate off its 2021 lows near 11.40.

But much of this price action could simply reflect profit-taking ahead of Thursday’s 09:00 London time decision from the Norges Bank.

“Norges Bank has guided for a rate hike in H2 2021. The recent decline in infection rates and the outlook for vaccine rollouts support this guidance, but the outlook is still very uncertain,” says Kyrre Aamdal, a senior economist at DNB Markets.

Consensus among economists suggests Norway’s central bank is likely to leave its cash rate unchanged at 0% while DNB Markets and other firms do not expect “any new signals” at this meeting, and instead expect the bank will wait until June or September before offering the market anything new to chew on.

As a reminder for readers, the central bank cited above-target inflation and an improving outlook for the domestic economy back in March for an unambiguous notice to the market that it’s likely to begin lifting the cash rate from current levels in the second half of 2021.

NOK charts

Above: Pound-to-Krone exchange rate at daily intervals alongside USD/NOK.

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“Although a rate hike in September cannot be ruled out, recent developments related to virus transmission, vaccines and restrictions suggest that Norges Bank will hold off on raising its key rate until this December. In order to slow the increase in home prices, it will then hike the key rate twice during 2022 to a level of 0.75 per cent,” says Lena Fransson, an economist for Norway at SEB.

There are plenty of reasons for why Thursday’s Norges Bank rate decision could pass without having any impact on the Krone or wider market and not least the long line-up of analysts and economists who expect it to say little new this week, however there are also reasons why a ‘hawkish’ surprise cannot be ruled out.

Norwegian inflation has accelerated sharply this year, rising above the 2% target and as far as 3.3% in February before dropping back only to 3.1% in March, while exchange rate and wage price developments since then have suggested that inflation could remain stubbornly elevated in the months ahead.

When the Norges Bank first guided in March that a rate rise could be seen in the second half of the year it did so at least partly on the understanding that “the krone appreciation and prospects for moderate wage growth suggest that inflation will move down ahead,” which has been a key driver of analyst expectations for a 2021 outperformance by the Norwegian currency.

This was because rising exchange rates can reduce inflation by cheapening the cost of imports, but since then the Norwegian Krone has depreciated against the Swedish Krona and appreciated only marginally against the Euro - which both account for around half of the trade-weighted exchange rate.

The Krone has also sat relatively unchanged against most of the majors since the March interest rate decision, indicating the currency market has done little if anything in the interim to bring inflation back down to the 2% target.

NOK rates

Above: Euro-to-Krone exchange rate at daily intervals alongside NOK/SEK.

Meanwhile, there have been indications of late that pay growth for workers could be stronger than was previously assumed by many economy watchers by the time that an end-May central wage negotiation is concluded.

The national employers’ organisation, or Confederation of Norwegian Enterprise, agreed a +2.7% pay increase for around 180k workers who’re represented by one of Norway’s largest unions last month, which could potentially influence other pay settlements agreed across the country this month. 

These two factors combined mean that upside risks to the Norges Bank’s inflation target are as potent as they were back in March if-not more so, which may be reason enough for a ‘hawkish’ surprise on Thursday even if this comes in the form of a mere indication that interest rates could rise sooner rather than later in the second half of the year.

Such an outcome would be likely to give any currency a lift irrespective of the market conditions although in light of the Krone’s underperformance since the Norges Bank’s last statement any recovery rally seen ahead of the weekend might be a noteworthy one which takes an unsuspecting market by surprise.

“Expansionary fiscal policy will cause the central bank to continue purchasing large amounts of NOK on a daily basis in 2021. We expect the krone to appreciate further against the euro and forecast that the EUR/NOK exchange rate will fall to 9.70 by the end of 2021,” says SEB’s Fransson.

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