News & analysis

The Norwegian krone has sold off over 6% against the US dollar since the start of the year predominantly due to a deterioration in the external climate.

The downturn in global growth prospects due to the coronavirus outbreak has not only fueled further dollar strength but also resulted in a softer euro.

More open economies, especially those with a strong correlation to commodity markets, took the brunt of the sell-off in the developed market space. Despite this change in external climate, our bullish NOK position remains intact in the medium-term.

More open economies, especially those with a strong correlation to commodity markets, took the brunt of the sell-off in the developed market space. Despite this change in external climate, our bullish NOK position remains intact in the medium-term.

We have adjusted our Q1 outlook, however, to account for the sudden depreciation in the krone and the deteriorating commodity outlook due to the coronavirus outbreak.

The view of a weaker krone in Q1 but a recovery in the medium-term sits in line with consensus expectations supplied to Bloomberg, although we maintain a more extreme path for USDNOK than median expectations – we forecast a larger NOK sell-off in Q1 while holding a more bullish view on the krone’s fortunes towards year-end.

NOK Forecasts

 

DETERIORATING EXTERNAL CLIMATE

The outbreak of the coronavirus impacted commodity linked currencies, especially those where growth is reliant on their trade balance. The Norwegian krone reflected the impact of this risk-off environment and hit its weakest level since 2001 as Brent prices fell to their lowest level since December 2018.

Oil markets were not just impacted on a spot level, but the futures curve also flattened – suggesting a rebound in Brent prices may not be forthcoming in the near future.

We expect the krone to recover along with risk appetite once the true extent of the economic damage from the coronavirus is gauged and met with a sufficient response from relevant authorities.

This would lead to a minor recovery in the price of Brent and risk-sentiment, filtering through into NOK strength. While this is likely to occur, determining the timing of such a recovery is more difficult and may occur later in Q2, rendering our Q1 forecast too bullish at 9.1 against the dollar.

 

Chart: The coronavirus has not only led to a cheaper price of spot Brent contracts, but also a flatter futures curve

A weak currency, tight labour market and above target inflation forced the Norges Bank to continue its hiking cycle at a time when global interest rates were falling. While this made the Norwegian central bank an anomaly in the global monetary policy space as other central banks shifted to more accommodative stances, rates remained below the long-run neutral rate projected at 2.0%.

The hiking cycle ended abruptly in September’s meeting when the central bank hiked rates to 1.5% but signaled policy would likely stay on hold in the short-run.

The latest Monetary Policy Report from December’s meeting highlighted that this cautious stance was likely to remain in place for much of 2020 due to the economy probably being near a cyclical peak. The latest policy projections released in the December MPR suggested a 40% chance of a 25 basis point rate hike in 2020.

The market doesn’t share this upward bias in rates, however, with a 12 basis point cut currently priced into the 1-year interest rate swaps. That being said, January’s CPI-ATE data, which adjusts for tax changes and excludes energy prices, confirmed the bank’s stance. This inflation measure rose 1.1 percentage points to 2.9%, with the price drivers being broad-based. This not only outstripped the markets’ expectations but also the central bank’s projections of 2.2% YoY.

While the real interest rate is projected to be close to 0%, monetary conditions are still supportive as the deposit rate sits some 50bps below the forecast neutral rate.

In the longer-run, conditions in Norway remain supportive of a higher policy path, especially if global growth conditions rebound and recent NOK weakness spur inflation to remain above the Norges Bank’s 2% target on a more structural basis.

 

RISKS

Despite domestic conditions remaining supportive of higher rates and a stronger NOK, the risks to this outlook remain plentiful.

The main risk comes in the form of the external climate, which may take longer to recover should the economic impacts of the coronavirus prove to be greater than markets initially thought, or authorities’ measures to bring Chinese growth back to trend prove to be underwhelming.

While our forecasts expect the recovery in external demand, global growth and risk sentiment to occur in Q1, it is highly likely that this source of stimulus for the NOK rally may be delayed until Q2.

Risks to the outlook also stem from lackluster eurozone economic growth. Economic activity in the currency bloc stagnated in 2019, prompting a weaker euro and also reduced demand for Norwegian exports.

Thus far, 2020 looks to be a continuation of this theme as growth conditions remain bleak and fiscal stimulus are deemed insufficient.

 

Chart: A lower oil price continues to weigh on the krone, but an improvement in risk appetite could cause this to reverse, and sharply

 

Author: Simon Harvey, FX Market Analyst at Monex Europe. 

 

 

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