The Norwegian krone enjoyed the decision by the Norges Bank to raise its projected interest rate curve to price in a rate hike in the latter half of 2021.
Having already projected take-off in the first half of 2022 back in January, the decision turned the already hawkish central bank even more hawkish. The krone immediately gained 0.84% against the euro, but even larger gains were realised against USD (1.02%) following the large policy divergence between the Fed and the Norges Bank after the FOMC’s dovish surprise from last night. The immediate gains reversed earlier losses driven by the broad rebound in the US dollar. However, despite the decision, the krone has reverted to trading marginally lower against the dollar today but still sits in the green against the euro, as broad USD strength persists on rising US yields.
NOK gains after NB signals it will hike rates in second half 2021
The decision was paired with fresh economic projections which reflected a faster pick-up in economic activity than previously forecasted, based on a smooth kick-off in the vaccination programme and a recovery in crude oil markets sending oil prices back to pre-pandemic levels.
The NB sees GDP rising to 3.8% in 2021 before rebounding to 3.4% and 1.2% in 2022 and 2023 respectively. Inflation expectations for 2021 are changed from 0.6% previously to 2.8%, with inflation recovering to 1.1% in 2022 and 1.5% in 2023. Along with the expected pick-up in inflation, the policy rate will likely be hiked in the second half of this year as the Bank states that a long period of low interest rates increases the risk of a build-up in financial imbalances. The Norges Bank acknowledged that despite the short term virus constraints on oil demand, consumption is expected to pick up as vaccination levels rise and economic conditions normalise, signalling an overall hawkish tone along with the revised rate path. This is something that distinguishes the Norges bank from many other central banks in the DM space: even the more hawkish central banks, like the Bank of England, tend to stress the short-term risks of the lockdowns and the uncertain outlook for the recovery.
Looking forward, the tighter policy signalling by the Norges Bank may give traders a preference for holding NOK over SEK, as the policy gap between the Norges Bank and the Riksbank widens.
Additionally, the growing divergence between the Norges Bank and the Federal Reserve will keep the Norwegian krone elevated across the board, especially combined with a fast economic recovery. Judging by today’s NOK reaction, markets didn’t see a hike in 2021 as premature and believe in the story of a leading Norwegian recovery, however, risks to the outlook remain until the vaccinations have progressed far enough to allow for further reopening and the economic data actually improves. The Norges Bank laid out a timeline for the easing of restrictions and sees all sectors subject to looser measures starting in May. Throughout the summer, containment measures will be phased out further, with workplaces and shops starting the reopening before the hospitality sector and travel sector joins at the end of summer. By September, the NB expects workplaces and shops to be fully reopened with the hospitality sector having few or no more containment measures in Q4 2021.
Overall, the outlook and balance of risks imply a continued expansionary stance for now, but once there are clear signs the economy is fully recovering, the Norges Bank will be the first to raise the policy rate gradually from today’s level.
Along with policy divergences, the timeline by OPEC+ to reverse production cuts and the further vaccine distribution and economy reopening will be key for NOK traders going forward.
Author: Ima Sammani, FX Market Analyst