News & Analysis

Today’s decision by the Norges Bank to hike rates by 25bps to 0.75% was widely expected by markets and came as no surprise, with the decision made unanimously among board members. Instead, the Norwegian krone initially rallied on the Norges bank’s more hawkish rate path projections, which now see the deposit rate at 1.32% by year-end instead of 1.11% previously.

The revision prompted a knee-jerk rally in NOK, but given that the hawkish adjustments fell in line with money market pricing, the Norwegian krone failed to hold onto gains vs the euro after the decision.

The Norges Bank’s new forecasts now not only see the key at 1.32% in Q4, but highlight continued policy tightening over the upcoming 2-year projection horizon.

This extreme level of forward guidance was compounded by commentary from Governor Bache in the policy statement. Bache stated that the policy rate “will most likely be raised further in June”.  The hawkish outlook comes at the same time as the medium-term GDP forecast being revised downwards, highlighting the growing stagflationary risk for European economies.  GDP forecasts were revised upwards for 2022 to 4.1% vs 3.5% and downwards for 2023 to 1.6% vs 2.0% previously. 2024 projections were unchanged. Inflation forecasts were revised upwards for the entire forecasting horizon, with 2022 inflation now seen at 2.5% vs 1.7% previously, while 2023 and 2024 figures sit at 2.4 and 2.5% respectively vs 2.0% for both previously. This is roughly in line with the 1-2 year inflation expectations as measured by the Norges Bank’s expectations survey, but remains somewhat lower in the longer-run.

Most of the NOK rally occurred ahead of the meeting, while the actual decision saw a kneejerk NOK rally and a subsequent retracement

While today’s decision was at least as hawkish as we expected, markets weren’t immediately convinced as the decision saw a knee-jerk reaction at first before currency traders pared back some of the immediate NOK gains.

Still, EURNOK sits marginally higher than pre-statement levels, suggesting money markets may have been looking for more – especially given that real rates are still deep in negative territory. In the near term, NOK outperformance related to monetary policy divergence is likely to remain prominent, especially against the euro. However, as both the ECB and Riksbank have shown a hawkish pivot in either communications or a policy decision, the krone’s outperformance may fade throughout the second half of the year if those divergences narrow as other central banks in Europe foresee more tightening.

Deeply negative real rates allow for further tightening

 

 

Authors: 
Ima Sammani, FX Market Analyst

 

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