Norges to Hike by 25bp, EUR/NOK Could Re-Test Year Highs

Summary

• Norges Bank (Norges) hiked the policy rate to 2.25% (+50bp) at their last meeting. They also updated their forecasts, notably indicating a 25bp hike to come on 3 November and a ~3.1% terminal rate to follow.
• Data since the last meeting has overshot forecasts, which could encourage a 50bp move, but the magnitude of the beats has been minimal. We believe they likely (75%) deliver a 25bp hike on 3 November.
• EUR/NOK has retreated from year highs as markets par their December European Central Bank (ECB) expectations while equities are bolstered by hopes of a Federal Reserve (Fed) pivot.
• In the near term, EUR/NOK could retest highs as markets attune to our expectations of a more hawkish Fed and ECB. Further afield, we think there is an opportune risk for a bullish NOK case.

Market Implications

• EUR/NOK could retest year-highs.

The Norges Bank Hiked 50bp But Added Dovish Twist

At its last meeting, Norges Bank hiked the policy rate to 2.25% (+50bp) – read our review here. It also came with an updated monetary policy report. Within this:

• They expected CPI-ATE (the Banks preferred measure of inflation) to reach 5% in the coming months and average 4.8% in 2023 (previously 3.3%).
• The economy (mainland) was expected to contract by 0.3% through 2023 (previously +1.1%) though they expected it to continue to grow through to year-end (+0.1% MoM SA expected).
• They expected unemployment to increase faster than before, reaching 2.3% in 2024. Meanwhile, they expect wages to grow by 4.6% next year (0.1pp higher than before).

The mix of higher inflation but a weaker economic outlook left the forecasted terminal rate practically unchanged at 3.1%, which they expected to reach by Q3 2023 (Chart 1).

Norges Likely Sticks With 25bp in November

Since the last meeting, inflation has printed higher than forecasted and did not turn over (CPI-ATE September: 5.3% YoY vs 5.0% forecasted), the unemployment rate has undershot (September: 1.6% vs 1.7% forecasted), and the krone has continued to depreciate (Charts 2, 3, and 4). It should apply pressure on Norges to keep up the pace with another 50bp hike. However, none of these misses have been material. We think it means they likely (75%) deliver a 25bp hike on 3 November.

Three Factors Keeping EUR/NOK Elevated

Our NOK trades have been tactical in nature. We think a fundamentally bullish case for the currency could lay further afield. For now, we think there are three things that are keeping EUR/NOK supported, and could, potentially, help it retest year highs.

ECB Underpriced, Supply Depressing Spread

The ECB hiked by 75bp (deposit rate: 1.5%) at its last meeting. From here Henry thinks a similar-sized move follows in December while net-supply should raise EGB yields too. It should help drive a wider spread against NOK yields. There is a clear risk to the upside for the Bund – Norway 2Y spread (Chart 5).

Natural Gas Threatens EUR/NOK Lower, But A Question of If Not Now, then When?

European natural gas prices have plummeted with demand flatlining as storage fillsacross the continent. As a result, NOK has become increasingly dislocated from spot price action (Chart 6). Going forward, a realignment would likely come through a colder winter than expected, i.e., storage empties faster than expected. This, however, is unlikely to happen in the immediate future with temperatures expected to remain above normal – separate analysis on this will follow. As a result, natural gas prices will not produce immediate strength for NOK. Further afield, strength could prevail.

Equity Bounce Leaves EUR/NOK Exposed to the Upside

The equity bounce has benefitted NOK. It is no surprise; 68.2% of the Norway Sovereign Wealth Fund is in equities (as of Q2) with it most closely linked to US equities – 42.6% of equity holdings are US-listed (as of 2021). The run could continue with equities benefitting from mostly solid earnings reports. However, we believe that a determined Fed will eventually spur equities into another bout of weakness, and, consequently further weakness in NOK.  Thus, a retest of year-highs is likely (Chart 7).

Norges Likely Sticks With 25bp in November While EUR/NOK Could Re-Test Year Highs

We continue to expect Norges to hike to policy rate by 25bp on 3 November, as forecasted by the Bank. And on FX, we expect this gradual move lower could come to an end, with the ECB underpriced, a bullish case for natural gas yet to return, and equities due to start another bout of weakness.

There are three risks to our view: (1) The ECB hikes by 50bp in December – they may fear that forcing a plan for QT and projecting a terminal rate is too much with a 75bp hike; (2) Demand returns, in force, for European natural gas – the main risk we have been noting; (3) Equities continue to rally – a Fed pivot would likely spur equities higher.

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)