Norwegian Krone: Norges Bank Heads for "Lift Off"

Norges Bank

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The Norwegian Krone is being tipped by a number of analysts we follow to perform strongly in the near future as they expect the Norges Bank to begin raising rates well before the Bank of England, Federal Reserve and European Central Bank.

Norway is a major oil producer and it is therefore little surprise to hear that the rising oil prices of recent weeks have supported the country's trade balance and currency. But hot inflation and an economy that has done better than many economists had expected during the covid-19 pandemic means the country's central bank is a major additional source of support for the currency.

"The Norwegian krone has been one of the big winners so far this year. The currency is receiving tailwinds from several sides, namely a friendlier economic outlook in the wake of the advancing global vaccination campaigns, a firmer oil price, and the prospect of a normalisation of monetary policy on the part of Norges Bank," says Thu Lan Nguyen, FX and EM Analyst at Commerzbank.

"Set against a relatively robust global recovery, the economic performance of Norway is likely to be very strong this year. Norway is also starting off from a stronger footing, after seeing less bruising in terms of GDP than many of its developed counterparts," says Paul Mackel, Global Head of FX Research at HSBC.

All eyes will turn to the Norges Bank on Thursday when they deliver their latest policy decision and offer guidance on the outlook.

Heading into the meeting investors are already confident that the central bank is on a path to raising interest rates sooner rather than later, therefore the Norwegian Krone could fall back if policy makers were to strike a more cautious-than-expected tone.

Markets expect at least one rate hike by the end of this year, but there are suggestions being made by some analysts that as many as two rate cuts are possible, a development that would be unreservedly bullish for the Krone if correct.

The case for raising rates at the Norges Bank is clear given inflation is now running well above the Bank's 2.0% target.

Inflation rose 3.30% in February, up from January's 2.5% and December's 1.4%.

Norway inflation rising

Concerns that a sustained period of inflation lies ahead could well force the hand of the Norges Bank to bring forward its first interest rate rise to 2021, a development that would be supportive of the NOK.

"The robust growth backdrop and incoming rate hikes are likely to be supportive of the NOK in the near future, in our view, and any increasing expectations of the Norges Bank hiking earlier and faster will only play into NOK strength," says Mackel.

The Norwegian Krone has risen 1.0% against the U.S. Dollar in 2021 and has gone 4.0% higher against the Euro.

However, against the Pound the Norwegian currency has lost 0.20% but the past month has seen Sterling's advantage dwindle dramatically. The Pound-to-Krone exchange rate is now at 11.75, having come under pressure during March and lost 2.50%.

"The NOK has been well supported," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole. "We remain in favour of buying the NOK."

GBP to NOK in 2021

But it is not just generalised inflation that is burning hot; house prices are now rising markedly with official statistics showing an acceleration in year-on-year house prices to 9.7% in February.

"Momentum in the housing market is another factor causing a headache at the Norges Bank, and the acceleration in year-on-year house price inflation in February, to 9.7%, will have done nothing to ease concerns," says David Oxley, Senior Europe Economist at Capital Economics.

Norway's economy meanwhile appears to be exiting the pandemic on a firm footing thanks to GDP only contracting 1.30% in 2020 which is less than the -7% recorded in the Eurozone and -9.0% in the UK.

Given hot prices and a relatively robust economy the Norges Bank finds itself in the unique position of being the only G10 central bank already talking seriously about returning interest rates to higher levels.

The central bank said at its December meeting that it envisaged the first interest rate rise to come in the first half of 2022, as opposed to the second half as had previously been the case.

"Concerns about financial stability may instead have prompted the monetary policymakers to consider earlier rate hikes. In their statement, they refer to the recent sharp rise in real estate prices and the dangers associated with a long period of low interest rates," says Nguyen.

Money market pricing now reflects a 25 basis point rate hike by the end of this year.

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How this expectation shifts on Thursday could well determine whether Krone exchange rates rally further or beat a retreat.

Crédit Agricole's Marinov says it is too early to expect another hawkish shift, but the Norges Bank will at the very least keep central bank rate expectations strongly supported which will benefit the currency.

But Commerzbank tell clients the market is premature in expecting an imminent rate rise and as a result Krone bulls could be disappointed.

"We do not expect a first rate hike until next year," says Nguyen. "We would be cautious here. After all, Norges Bank has in the past often enough demonstrated quite a high tolerance for stronger inflation spikes (both upward and downward) and instead placed more emphasis on stable economic growth.

"The NOK bull case could suffer a setback for a while if the Norges Bank mentions currency as one consideration delaying any eventual intent to hike the deposit rate," adds John Hardy, Head of FX Strategy at Saxo Bank.

Analysts at Capital Economics say the Norges Bank is "preparing for lift off". Although they do not expect an interest rate rise to be announced at the March policy meeting, they do expect a bullish signal to emerge from the central bank.

"The Norges Bank will probably leave its key interest rate on hold at zero next Thursday, but we expect it to adopt a much more hawkish tone than it has up to now," says Oxley.

Capital Economics forecast two 25bp hikes in the second half of 2021 and another two in the first half of 2022, which would take the key interest rate to 1.00%.

"This is more hawkish than is currently priced into the market. We are also bullish on the Norwegian krone, forecasting it to rise to EUR 9.5 by year-end (from 10.10 currently) and to rise further above parity against the Swedish krona," says Oxley.

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