Norges Bank Preview - Danske Bank

Investment Research

13 March 2017

Norges Bank Preview Unchanged rates and neutral bias maintained 

We expect Norges Bank (NB) to keep the sight deposit rate unchanged at 0.50% at Thursday’s meeting and over the next 12 months.

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Economic activity data have been encouraging over the past months. The Regional Network Survey points to stronger growth, unemployment is falling and oil investments have been adjusted upwards. In addition, the housing market continues to tighten. On the other hand, inflation has surprised significantly to the downside. Hence, we expect the Board to reiterate a ‘neutral’ bias.

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The developments since the December meeting suggest an upward revision to the rate path. However, the recent drop in inflation will probably be sufficient to keep a 10-20% probability of another rate cut before year-end.

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The risk to our call is skewed to the upside, as diminishing downside risks to growth and continued upside risks from financial stability could remove the possibility of a rate cut.

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Markets price unchanged rates on Thursday and roughly one hike at the end of 2018. We suggest selling NOK FRA 3m DEC 2017 and buying NOK FRA 3m DEC 2018. Strategically, we recommend building up NOK longs but tactically we prefer a cautious stance ahead of the Fed. Look to sell EUR/NOK around 9.25-9.30.

Developments since December have been encouraging The February Regional Network Survey confirmed our expectations of a return to trend growth around 2% (annualised) for the next six months (Chart 1). The improvement was broad based, with improvement across all sectors and regions. Employment expectations improved as well and signal the strongest growth in employment for almost four years. In addition, both the unemployment figures and the capacity restrictions in the survey suggest capacity utilisation is higher than NB expected in December (Chart 2). Besides, the recent oil investment survey revealed an upward adjustment to the 2017-estimate, implying a less pronounced fall in oil investments than previously expected (Chart 10). As the oil price, until recently, has stabilised in the USD50s/bl and break-even costs have dropped below USD30, the risks of another downside shock are clearly decreasing. Core inflation has been considerably lower than expected. In February the discrepancy was 0.95pp, which resulted in a considerable downward push on the interest rate path. The undershooting is primarily due to lower imported inflation than expected, but even domestic inflation has dropped significantly. NB, in line with most analysts, has for a long time expected inflation to drop as the effects from NOK depreciation gradually fade and eventually turn (Chart 3). If imported inflation just drops faster than expected, there is no reason to pay too much attention to this in the monetary policy decisions. On several occasions, NB has stressed that as long as inflation expectations remain well anchored, the central bank can ignore temporary changes to inflation. In the annual address in February, governor Olsen described the period after the oil shock and stated that: ‘The krone exchange rate fell in tandem with the oil price and led to higher prices for imported goods, resulting in a temporary increase in inflation. Since there is confidence that inflation will remain low and stable, we have been able to disregard that increase when setting monetary policy.’

Important disclosures and certifications are contained from page 7 of this report.

Chart 1. Downside risk much reduced

Source: Norges Bank, Macrobond Financial, Danske Bank Markets

Chart 2. Capacity utilisation suggests a higher rate path

Source:, Macrobond Financial, Danske Bank Markets

Chart 3. …but core inflation has disappointed

Source: Bloomberg, Macrobond Financial, Danske Bank Markets

Chief Economist Frank Jullum +47 45 25 85 29 [email protected] Chief Strategist Jostein Tvedt +47 23 13 91 84 [email protected] Senior Analyst Kristoffer Kjær Lomholt +45 45 25 85 29 [email protected]

www.danskeresearch.com

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Hence, as inflation expectations described in NB’s Expectation survey currently seem well anchored (Chart 4), we expect NB to show a great deal of patience regarding the latest fall in inflation. Wage growth could be adjusted downwards but we think the scope for reduction is limited. In the December report, NB expected wage growth in 2017 to increase to 2.8%. Based on the results from NB’s Expectation survey, wage growth is expected to end in the 2.5-2.6% area (Chart 28). The import-weighted NOK (i.e. I44) has on average been roughly 0.7% weaker than NB expected in December (Chart 16). Given the latest fall in the NOK, the I44 spot is now 2.6% weaker than the quarterly projection, hence the currency is an argument for an upwards revision of the rate path. Once again, global developments argue for higher Norwegian rates, with global forward rates having climbed since December, pulling the rate path upwards (Chart 24). Also, leading indicators point to an acceleration in global growth, albeit the effect on the rate path will be limited. Finally, the housing market continues to tighten (Chart 22). There is no straightforward way of calculating the effect on the rate path, despite the new inclusion of this factor in December (Chart 5). To be sure, the tight housing market and strong credit growth are more important factors in the risk assessment, but at some point this has to be formalised in the decision process. For now, it merely keeps the bar for rate cuts rather high.

… and we expect a neutral bias in the statement The December MPR interest rate path indicated a 40% probability of a rate cut by the end of 2017 (Chart 6). Since then, developments point to an upward adjustment of the rate path. The big question is of course whether the adjustment will be sufficient to point to unchanged rates going forward. Unfortunately, there is no way of calculating this accurately, as the difference is limited to a few basis points. However, after the latest inflation figures, we expect the rate path to indicate a roughly 10-20% probability of another rate cut before year-end. However, we still expect that the Board will continue to signal a neutral bias, as downside risks to growth are clearly diminishing, whereas upside risks from financial stability persist. Hence, the risk to our call is skewed to the upside, as NB may remove the rate path cut probability entirely.

Strategy: play relative FRAs, gradually build up NOK exposure Given a MPR in line with our expectations, market reactions will probably be somewhat muted. However, the 3M Nibor spread over the sight deposit is still a bit elevated, which suggests that short end FRAs may come down slightly. The market at present only discounts approximately one hike by the end of 2018. The international environment, combined with the domestic business cycle recovery, may suggest that the market discounts a too low probability of a tighter monetary policy in 2018/2019. We still believe there is some value in a steeper FRA curve for 2018. We suggest selling NOK FRA 3m DEC 2017 and buying NOK FRA 3m DEC 2018. Note that the December 2017 FRA at present is above the March 2018 contract due to year-end liquidity effects, which suggests that the December contract may be relative volatile. As the NB meeting is not expected to have significant a market impact, the near-term EUR/NOK outlook remains in the hands of the oil price and EUR rates (which can explain 90% of last week’s move higher). However, from a long-term perspective, domestics suggest the latest NOK weakening constitutes an attractive buying opportunity. Indeed, accelerating above-trend growth and a narrowing output gap is theoretically the ideal cocktail for an undervalued currency like the NOK. Strategically, we therefore recommend gradually building up NOK longs while tactically we prefer a cautious stance ahead of the Fed. Given our view on the ECB, positioning, NOK technicals vs SEK and USD, and given the expected spot effect from a temporary dip in oil, we would be inclined to sell EUR/NOK around 9.25-9.30.

2 | 12 December 2016

Chart 4. Inflation expectations remain well anchored according to Norges Bank’s expectations survey


Chart 5. In December, ‘financial imbalance and uncertainty’ was included as explicit factor (black) pp 0.40

Contributing factors for NB rate path changes

0.20

0.00

-0.20

-0.40

Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Q2 18 Q3 18 Q4 18 Q1 19 Q2 19 Q3 19 Q4 19

Financial imbalances and uncertainty Exchange rate Foreign interest rates Total

Money market premiums Prices and wages Demand


Chart 6. NB to lift rate path


Chart 7. We suggest selling NOK FRA 3m DEC 2017 and buying NOK FRA 3m DEC 2018



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Norges Bank chart pack Chart 8. NB’s December rate path suggested a 40% probability of a rate cut. We expect this to be reduced

Chart 9. The Regional Network Survey paints a much brighter picture of the economic outlook



Chart 10. 2017 oil investments have been revised higher since the last monetary policy decision

Chart 11. Actual GDP growth has been marginally weaker than pencilled in by NB

Source: Macrobond Financial, Bloomberg, Danske Bank Markets


Chart 12. Fiscal policy remains expansionary, albeit less so than in 2016

Chart 13. Manufacturing sector seems to stabilise

Source: Ministry of Finance, Macrobond Financial, Bloomberg, Danske Bank Markets

Source: SSB, Macrobond Financial, Bloomberg, Danske Bank Markets



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Chart 14. Oil curve slightly below the December projection

Chart 15. The oil price measured in NOK has risen substantially over the last year (despite the latest drop)

Source: Norges Bank, Macrobond Financial, Bloomberg, Danske Bank Markets


Chart 16.The NOK is weaker than pencilled in …

Chart 17. … which is a result of a lower oil price and not least stronger EUR, SEK, RUB and BRL pp

I44 Contributions since last MPR (90% of basket)

0.70

8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0%

0.50 0.30

0.10 -0.10 -0.30 -0.50 -0.70

Contribution (lhs)

%-Change (rhs)

I44 change (rhs)



Chart 18. 3M Nibor pricing is higher than NB expected

Chart 19. … despite the Nibor-policy rate spread narrowing faster than pencilled in





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Chart 20. Lending rates have reached a bottom

Chart 21. Lending rates have risen over the past quarters



Chart 22. House prices higher than NB’s forecast as Oslo house price growth accelerates

Chart 23. Credit growth somewhat lower-than-expected but remains above disposable income growth of households



Chart 24. Foreign rates close to NB’s expectations (slightly higher)

Chart 25. Growth outlooks of close-trading partners have improved marginally





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Chart 26. Core inflation has surprised strongly to the downside reflecting not least a strong drop in imported inflation (NOK effect falling out as the currency has stabilised)

Chart 27. Drop in core inflation could be seen as ‘earlier-thanexpected’ and is not an argument for easier policy at this stage



Chart 28. NB’s wage forecasts seem optimistic…

Chart 29. …as indicated by wage expectations



Chart 30. Above trend growth and a narrowing output gap is an ideal cocktail for an undervalued currency like the NOK

Chart 31. We suggest selling NOK FRA 3m DEC 2017 and buying NOK FRA 3m DEC 2018





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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 Frank Jullum, Chief Economist, Jostein Tvedt, Chief Strategist, and Kristoffer Kjær Lomholt, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in this 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. Danske Bank’s research reports are prepared in accordance with 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 a 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.

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