Norges Bank Review Unchanged but September cut still in store Frank Jullum Chief Economist +47 85 40 65 40 fju@danskebank.dk Kristoffer Kjær Lomholt Analyst +45 45 12 85 29 klom@danskebank.dk 23 June 2016 www.danskebank.com/research Investment Research Follow us on Twitter @Danske_Research Important disclosures and certifications are contained from page 9 of this report.
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 70-100% 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 20-25 figures while a Bremain would lower the cross to 9.20-30. Irrespective of the vote, we think the NOK upside potential will remain the largest on a 6-12M horizon. 2
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 70-100% 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- 2017 and throughout 2019. 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. 2016 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
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 2019. The stronger NOK is pushing the path downwards but is mainly explained by higher oil prices. Contributing factors behind the higher rate path... PP 0.60 0.50 0.40 0.30 0.20 0.10 0.00-0.10-0.20-0.30-0.40-0.50 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 30/09/2016-0.07 0.03 0.14 0.00-0.01-0.02 0.07 31/12/2016-0.12 0.05 0.20-0.01-0.01-0.09 0.02 31/03/2017-0.17 0.06 0.33-0.03-0.02-0.12 0.05 30/06/2017-0.17 0.06 0.37-0.04-0.02-0.14 0.06 30/09/2017-0.16 0.07 0.39-0.06-0.02-0.15 0.07 31/12/2017-0.15 0.06 0.40-0.07-0.02-0.15 0.07 31/03/2018-0.14 0.06 0.42-0.09-0.02-0.15 0.08 30/06/2018-0.12 0.05 0.41-0.10-0.02-0.14 0.08 30/09/2018-0.11 0.04 0.39-0.10-0.02-0.14 0.06 31/12/2018-0.09 0.03 0.38-0.11-0.02-0.13 0.06 31/03/2019-0.08 0.03 0.37-0.11-0.02-0.12 0.07 30/06/2019-0.07 0.02 0.36-0.12-0.02-0.11 0.06 30/09/2019-0.05 0.02 0.36-0.12-0.02-0.10 0.09 31/12/2019-0.04 0.02 0.35-0.12-0.02-0.08 0.11 Source: Norges Bank, Danske Bank Markets 4
Growth forecast lowered Growth forecast cut more than expected Mainland growth was adjusted downward by 0.2pp for 2017-19. 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 2017. 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
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 2017. Wage growth has been lowered by 0.1pp for 2016 and 2017, and 0.2pp for 2018. 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
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
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 20-25 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 9.20-9-30 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
Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The authors of this research report are listed on the front page. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. 9
General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report was created by Danske Bank A/S and is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to U.S. institutional investors. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non-u.s. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission. 10