Norges Bank Review. Unchanged but September cut still in store. 23 June Follow us on

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1 Norges Bank Review Unchanged but September cut still in store Frank Jullum Chief Economist Kristoffer Kjær Lomholt Analyst June Investment Research Follow us on Important disclosures and certifications are contained from page 9 of this report.

2 Main points As expected, Norges Bank (NB) this morning left the sight deposit rate unchanged at 0.50%. The revised rate path still has a 100% implied probability of a 25bp rate cut in H2 16. As NB only publishes the rate path with two decimals, we have a % implied probability of the cut coming at the next meeting in September. The implied probability for zero rates in Norway was cut from 20% in March to 0% in today s Monetary Policy Report. Market reaction. Prior to the decision, markets had priced in around a 10% probability of a rate cut today. Post the decision, short-term rates have risen slightly but markets still price in close to a full rate cut on a 12M horizon. EUR/NOK has fallen moderately as expected. Our expectation. Overall, the rate path was marginally more hawkish than we expected, as we believed NB would keep a small (5-10%) probability of a cut to 0%. Overall, we think today s decision supports our call that NB will cut the sight deposit rate by 25bp to 0.25% in September and that this will mark the final cut in this cycle. FX. The short-term NOK outlook will be closely tied to the result of the UK s EU referendum. In our view, a Brexit would send EUR/NOK higher by figures while a Bremain would lower the cross to Irrespective of the vote, we think the NOK upside potential will remain the largest on a 6-12M horizon. 2

3 Unchanged and marginal upward revision to rate path New rate path still has a guaranteed rate cut in H2 Today, Norges Bank decided to leave the sight deposit rate unchanged at 0.50%. This was in line with expectations. In the corresponding Monetary Policy Report (MPR), the revised rate path has a 100% implied probability of a 25bp rate cut in H2 16. As NB only publishes the rate path with two decimals we have a % implied probability of the cut coming at the next meeting in September. The implied probability for zero rates in Norway was cut from 20% in March to 0% in today s Monetary Policy Report. Overall, the rate path was a bit higher than our expectations, due to a revision to the estimated trend growth, which increases the output gap despite the downward adjustment of growth rates. This explains the lack of downward adjustment of the rate path from mid and throughout We still expect NB to cut rates by 25bp at the September meeting. However, on balance the probability has fallen somewhat on the back of the latest change in the risk outlook for the economy but no longer a probability of an additional cut Source: Norges Bank, Danske Bank Markets Markets price in close to a full rate cut on a 12M horizon Source: Danske Bank Markets 3

4 Rate path lift driven by domestic demand Arguments Norges Bank has revised the estimated trend growth, which increases the outputgap despite lower growth estimates. More expansive fiscal policy is pulling the rate path upwards as well. As the central wage negotiations came out lower than expected, wage growth has been adjusted downwards and is pushing the path down. Higher money market spreads (versus the folio) add some basis points on the downside. Foreign forward rates have dropped, pushing the rate path downwards, but especially from late 2017 and throughout The stronger NOK is pushing the path downwards but is mainly explained by higher oil prices. Contributing factors behind the higher rate path... PP Factors behind changes to the rate path Exchange rate Lending margins Foreign interest rates Private demand Public demand Wages Sum Wages Public Private Foreign Lending Exchange demand demand interest margins rate Sum 30/09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ Source: Norges Bank, Danske Bank Markets 4

5 Growth forecast lowered Growth forecast cut more than expected Mainland growth was adjusted downward by 0.2pp for However, the main factor behind the adjustment is a revision of the expected trend growth in the mainland economy. Actually, the output gap is adjusted upwards by 0.1pp in 2016 and The unemployment rate is adjusted marginally lower, as actual unemployment rates have surprised on the downside. GDP forecasts lowered Source: Norges Bank, Macrobond Financial, Danske Bank Markets... but minor changes to the oil investment forecasts Source: Norges Bank, Macrobond Financial, Danske Bank Markets 5

6 Inflation forecast lowered Wage growth lowered and stronger NOK Inflation projections lowered slightly Norges Bank cut its core inflation projections by 0.1pp for 2016 and 0.2pp for Wage growth has been lowered by 0.1pp for 2016 and 2017, and 0.2pp for In addition, the stronger starting point for the importweighted NOK results in a roughly 2-2.5% stronger NOK compared with the March report. Source: Norges Bank, Danske Bank Markets partly due to lower wage growth Source: Macrobond Financial, Danske Bank Markets 6

7 Norges Bank lifts I44 NOK forecast profile (weaker NOK) Weak for longer As expected, Norges Bank lowered its forecast for the import weighted NOK index (i.e. it has shifted the NOK profile to a stronger level). As the chart on the right shows, this is the first time in many years. Norges Bank relifts the I44 forecast... In the MPR, Norges Bank argued that the upswing in oil prices and a slight increase in the interest rate differential against other countries have contributed to an appreciation of the krone exchange rate measured by the import-weighted exchange rate index (I-44). Higher oil prices may have reduced market uncertainty regarding growth prospects for the Norwegian economy and contributed to a reduction of the risk premium for NOK. So far in Q2, the krone exchange rate has on average been 2.4% stronger than projected in the March Report....and expects range trading in coming quarters The revised I44 projection still implies only a gradually stronger NOK in the coming years. The appreciation tempo is little changed from the March MPR. Overall, this is in line with our own view (see overleaf). * The I44 is the NOK index that Norges Bank forecasts and currently the EUR (34%), SEK (13%), CNY (10%), GBP (7%), DKK (6%) and USD (6%) make up the majority of the index. Source: Macrobond Financial, Danske Bank Markets 7

8 FX implications for EUR/NOK Initial reaction As expected, EUR/NOK moderately dropped on the rate announcement and the MPR release (see margin chart). The short-term NOK outlook will be closely tied to the result of the EU UK referendum. In our view a Brexit would send EUR/NOK higher by figures. EUR/NOK outlook under our Bremain base case scenario Tomorrow. We expect risk relief and the growth tail-risk removal of Norway s closest trading partners to send the Brent crude oil price towards USD52/bbl. According to our short-term financial models, this should return EUR/NOK to the range. 1-6M. A Bremain does not alter our view that while the NOK seems fundamentally undervalued from a long run perspective the deterioration in Norwegian competitiveness over the past decades limits the short-term NOK-upside potential. We expect Norges Bank to cut rates for the final time in September (not fully priced in) and private sector growth to remain vulnerable to a significant NOK appreciation. We forecast EUR/NOK at 9.30 in 3M and 9.20 in 6M. 6-12M: We expect an economic recovery in Norway towards trend growth in 2017, a gradually higher oil price, a repricing of monetary policy post the final September cut and general valuation to send EUR/NOK lower towards 8.90 in 12M. EUR/NOK somewhat lower as expected Source: Bloomberg, Macrobond Financial, Danske Bank Markets The NOK is no longer a safe-haven currency Source: Bloomberg, Macrobond Financial, Danske Bank Markets 8

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