FX Watch – Norwegian krone: Glass half full

by: Georgette Boele

In this publication: Since 22 February the NOK has fallen by 7% versus the euro, because of lower oil prices, a narrowing yield spread and perceived lower eurozone political risks. We downgraded our view on monetary policy and the krone. The NOK is likely to stay under pressure in the near-term, but to strengthen later this year and next year, because we expect oil prices to recover, the Norges Bank to hike earlier than the ECB and fundamentals to remain strong.The krone is also at relatively cheap compared to other G10 FX.

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Introduction

The Norwegian krone had a good start to the year and appreciated by close to 3% in the first two months of the year. Then, its fortunes changed dramatically. Since 22 February the Norwegian krone has lost more than 7%. What has happened? First, all possible positive news was reflected in the price and the Norwegian krone did not rise anymore on positive news. As a result, investors started to close some of their long positions. Second, the oil price came under pressure in March which resulted in more profit taking in the Norwegian krone. The krone has a strong tendency to move in tandem with oil prices (see graphs below) as weaker oil prices result in a downward adjustment in expectations about the Norwegian economy and future monetary policy.

Third, on 10 March, inflation came in far below the expectations resulting in a downward adjustment in expectations about monetary tightening this year and next year. Fourth, the 10y government yield bond spread between Germany and Norway has narrowed (less negative) making the krone a less attractive investment (see graph on the left below). Last but not least, optimism about an EU friendly election outcome in France has calmed investors’ nerves (lower France CDS spread). As result, the euro has recovered and investors became less motivated to diversify out of the euro into a non-eurozone (European) currency such as the Norwegian krone (see graph on the right below).

Momentum is negative…

Today, the Norges Bank decided on monetary policy. It left official rates unchanged at 0.5%. Moreover, the statement was on the dovish side. It said that “it was the Executive Board’s assessment that there was a continued need for an expansionary monetary policy. Capacity utilization in the Norwegian economy was assessed to be below a normal level, and inflation was expected to range between 1-2% in the coming years”. So the Norges Bank expects inflation to decline. This outcome has resulted in extra downward pressure on the krone.  On 10 May inflation for April will be released. Lower-than-expected numbers will likely result in more krone weakness in the near-term.

 …and we have downgraded our monetary policy call and the NOK…

Up to now, we have been of the opinion that the Norges Bank would deliver two rate hikes of 25bp each this year. However, taking another look at the recent developments, this has become unlikely. Therefore, we now expect that the Norges Bank will hike interest rates early next year. Our new EUR/NOK forecasts reflect this change in view. Our new year-end forecasts for 2017 and 2018 in EUR/NOK are 9.25 (previously 8.5) and 8.5 (previously 8.0), respectively. However, we still expect the Norges Bank to hike at least six months before the ECB.

…but we think the glass is half full

Even though the current momentum is negative, we are more optimistic about the krone’s outlook. For a start, we expect Brent oil prices to rise to USD 60 per barrel before the end of the year. This should give strong support to the Norwegian krone. Moreover, we don’t expect a sharp drop in inflation and we expect the economy to perform well. Furthermore, in the coming weeks and months investors will probably realise that the Norges Bank is likely to raise interest rates before the ECB. This should also the krone. What is more, the fundamentals of the Norges krone are pretty strong. Norway has a current account and fiscal surplus and via its Petroleum Fund it has put money aside for bad times. Last but not least, the Norwegian krone together with the Swedish krona is one of the most undervalued currencies within G10 FX according to purchasing power parity. In short, we would use further weakness in the krone versus the euro as an opportunity to position for strength later this year and next year. At the moment it is too early to position, we wait for more extreme conditions. For example if EUR/NOK moves towards 9.75.