norges bank preview - danske bank · both q1 gdp figures and the regional network survey suggest...

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Norges Bank Preview 20 June 2016

’Unchanged’ but strong easing bias reiteratedFrank Jullum

Chief Economist

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[email protected]

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Important disclosures and certifications are contained from page 14 of this report.

Jostein Tvedt

Chief Strategist

+47 23 13 91 84

[email protected]

Kristoffer Kjær Lomholt

Analyst

+45 45 12 85 29

[email protected]

Follow us on Twitter @Danske_Research

2www.danskebank.com/CI

Main points

• We expect Norges Bank (NB) to keep the policy rate unchanged at 0.50% while reiterating the strong easing

bias from the March Monetary Policy Report (MPR).

In the MPR from March, NB indicated a 50% probability of a June cut conditioned on no policy change in May. NB also indicated a 100% probability of a cut before Q4 and an additional 20% probability of zero rates.

• Developments since March have been close to NB’s projections although overall it will be hard for NB to strike

as dovish a tone as in MPR 1-16 given the revised fiscal budget, the higher oil price, the lower tail risk of the Norwegian economy falling over a cliff and the latest acceleration in house prices. As a result, we expect NB to

marginally lift the rate path but still signal a very high likelihood of a September cut.

Specifically, we expect the revised rate path to signal a 80-90% probability of a September rate cut and a 5-10% probability of an additional rate cut to zero. Conditioned on no cut in June these probabilities were 100% and 20% in March, respectively.

We expect NB to reiterate the message from March on proceeding with greater care in setting rates.

• Balance of risk. Overall, we think the risk to our call is very balanced. On the downside, NB could decide on leaving the rate path unchanged but it is difficult to see what should drive a lower rate path. On the upside, NB could fully incorporate the revised fiscal budget and a strong concern with accelerating house prices but as it is very aware of keeping the NOK weak, it is our view that NB is also very aware of not striking too hawkish a tone at this stage.

• Market pricing. Markets are pricing in around 2bp worth of cuts for Thursday, 10bp for the September meeting and an accumulated 25bp on a 12M horizon (the point where the most easing is priced in).

• FX, rates and fixed income strategy. In isolation, we anticipate a muted market reaction to the MPR release albeit with some moderate support to the NOK. We expect risk sentiment in relation to the coinciding EU UK referendum to be the clear dominant driver for market pricing this week.


NB decision: ‘unchanged’ but strong easing bias reiterated

We expect NB to keep rates unchanged at 0.50% while reiterating the strong

easing bias from previous meetings.

• The rate path from March was very soft by suggesting a 50% probability for a rate cut in June (conditioned on no policy change in May), a 100% probability of a rate cut before Q4 16 and a 20% probability of an additional cut to 0%.

• At the same meeting, however, NB also emphasised that ‘as the key policy rate

approaches a lower bound, the uncertainty surrounding the effects of monetary

policy increases’. This now suggests proceeding with greater caution in interest

rate setting’. This message is likely to be reiterated on Thursday.

• On the whole, developments since March have not deviated substantially from

the projections in the MPR 1-16 (see slides 4, 6-13 for an overview and more details).

• Despite the urge to keep an easing bias to support a weak NOK, in our view, it will be hard for NB to avoid a less dovish tone than back in March. Specifically, we expect the revised rate path to signal a 80-90% probability of a September rate cut and a 5-10% probability of an additional rate cut to zero. Conditioned on no cut in June, these probabilities were 100% and 20% in March, respectively.

• Overall, we think the risks to our call are very balanced. On the downside, NB could decide on leaving the rate path unchanged but it is difficult to see what should drive a lower rate path. On the upside, NB could fully incorporate the revised fiscal budget and a concern with accelerating house prices but as it is very aware of keeping the currency weak, it is our view that NB is very aware of not striking too hawkish a tone at this stage.

• We still expect NB to cut the sight deposit rate in September, marking the final

rate cut in this cycle.

Markets price in 25bp cut on a 12M horizon

* Estimated from stripped FRAs

Source: Macrobond Financial, Danske Bank Markets

The tails risks have diminished



Factor summary

Relative to NB’s March Monetary Policy Report (MPR):

Both Q1 GDP figures and the Regional Network survey suggest domestic

growth is picking up, but roughly in line with NB’s expectations from the March report. However, the revised fiscal budget revealed a larger increase in fiscal stimulus in 2016, which should be visible in H2.

Core inflation has been exactly in line with expectations, but the wage

negotiations seem to have delivered an outcome below 2.5%, whereas NB expected 2.6% in 2016 back in March. This will pull the rate path downwards.

The money market spreads have been roughly 10bp higher than expected, which could pull the rate path down by 5bp. However, NB seems to have addressed this problem through direct liquidity measures, so this effect could be excluded.

The import-weighted NOK has been roughly 2.5pp stronger than expected, which seen in isolation should pull the rate path downwards by c. 15-20bp. However, as NB pointed out at the May meeting, the appreciation of the NOK must be seen in connection with the significant rise in the oil price. Hence, we expect these factors to net out and have no aggregate effect on the rate path.

Housing prices and household debt have increased considerably more than expected in March. This could reintroduce the concern of low interest rates increasing the risk of financial imbalances and weigh on the decision. This will not affect the rate path but could have an impact on the overall risk assessment, which is key.

Global forward rates are somewhat below NB’s March forecasts – especially at the longer end. This is partly due to the global growth outlook, which is also a little weaker than projected. Source: Macrobond Financial, Danske Bank Markets

The latest house price data will influence

the risk assessment

Factors suggest a marginally higher rate path



Strategy: EU UK referendum set to dominate

Thursday’s NB meeting coincides with the long-awaited UK EU referendum, which we think will be a more important market driver than the NB meeting.

Rates/fixed Income

• Driven by ‘Brexit’ fears, NOK rates have fallen recently leading to a market pricing much closer to NB’s March projections. We estimate that markets are pricing in around 2bp worth of cuts for Thursday, 10bp for the September meeting and an accumulated 25bp on a 12M horizon (the point where the most easing is priced in).

• As we do not expect any major changes to the rate path, we think the marketreaction to the MPR release will be muted. Also, while at the press conference NB may address a readiness to cut interest rates further in case of a ‘Brexit’, this will hardly be surprising to the market. As a result, we suggest no specific

strategy related to the upcoming NB meeting.

FX

• In isolation, we anticipate some moderate support to the NOK on the MPR release. Importantly, we think a ‘Brexit’ would send EUR/NOK higher. The primary reason for this is that we expect risk sentiment to weigh on the NOK, which is no longer a safe-haven currency. Also, higher uncertainty and recessions in Norway’s closest trading partners would weigh on oil prices and lead markets to price in more NB easing. Importantly, we do not expect an EU crisis to develop into a EUR crisis at this stage, which limits the EUR downside on a ‘No’ vote on 23 June.

• In our base case of a ’Bremain’, we expect higher growth in Norway, a gradual higher oil price, a repricing of monetary policy post the final September cut and general valuation to send EUR/NOK gradually lower towards 8.90 on a 12M horizon. We recommend clients utilise spikes higher in EUR/NOK over

the coming months to increase NOK exposure.

‘Brexit’ risk has driven NOK rates lower recently

We think a ‘Brexit’ would send EUR/NOK higher

Source: Bloomberg, Macrobond Financial, Danske Bank Markets

Source: Bloomberg, Macrobond Financial, Danske Bank Markets

0,5

0,7

0,9

1,1

1,3

1,5

1,7

1,9

2,1

2,3

jul-2016 jul-2019 jul-2022 jul-2025

NOK 3m FWD NOK 3m FWD 14 days ago


The outlook (1/8) – domestic economy

• Mainland GDP was up 0.3 % q/q in Q1, a bit higher than NB assumed in March, due partly to higher electricity production.

• The May Regional Network Survey confirmed that growth is picking up in line with previous expectations. More importantly, there are now clear signs of growth accelerating outside the oil sector, which should reduce the risk of severe second-round effects of the oil shock.

• The revised budget revealed an increase of the fiscal impulse of 0.4pp, or NOK10bn. In isolation, this should pull the rate path upwards by almost 20bp.

Regional network survey still points to zero growth

in the private sector for the coming quartersSigns of acceleration outside the oil sectors

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


The outlook (2/8) – the oil price and oil investments

The spot oil price in line with expectations,

the forward curve below.No surprises from the oil investment survey

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

• The oil price has been roughly USD10 p/b higher than at the March meeting. The effect on oil investments and hence the economy, will be little affected in the short run. In our view, however, the downside risks to the economy are considerably lower as a result of the higher oil prices.

• The Q2 oil investment survey came out as expected, and there should be no reason for NB to make any major revisions to the oil investment forecasts.


The outlook (3/8) – inflation

Core inflation exactly in line with expectations…


… as the NOK effect on imported prices fades


• May core inflation was exactly as projected by NB in the March MPR, having been marginally lower in March and April.

• The deviations are too small to have any effect on the rate path.


The outlook (4/8) – wage growth

Regional Network Survey points to lower wage growth… ... and so does the expectations survey

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

• The results of the central wage negotiations are now mainly finished. The outcome seems to be overall wage growth in the region of 2.4% in 2016. This is 0.2pp lower than NB assumed at the March PPR and will in isolation pull the rate path a few basis points downwards.


The outlook (5/8) – money market and credit spreads

Tight liquidity has increased money market spreads Lending rates close to unchanged

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

• The money market spreads have been roughly 10bp higher than expected, which could pull the rate path down by 5bp. However, NB seems to have addressed this problem through direct liquidity measures, so this effect could be excluded.


The outlook (6/8) – foreign demand and foreign rates

Foreign interest rates significantly below projections Increased global risks

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

• The global outlook is more or less in line with the expectations from March’s MPR. The recent turmoil is probably a result of the uncertainty from a possible Brexit. As the result of the referendum will be unknown at the time of the MPC meeting, this should not affect the decision at NB.

• Global forward rates are close to 10bp lower than ahead of the March meeting, which should push the rate path downwards by roughly 5bp.


The outlook (7/8) – financial stability and house prices

Housing prices have increased more than expected … and so has household credit growth

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

• There has been a remarkable acceleration in housing prices since March. The annual growth rate was 7.2% in May, compared with the 4.1% NB expected for Q2.

• The corresponding growth in household debt is, of course, also higher than NB assumed in March.

• Needless to say, this reintroduces the risk of financial instability resulting from a lax monetary policy. On margin, this will make further monetary policy stimulus less likely.


The outlook (8/8) – the exchange rate

• The import-weighted NOK has been around 2.5% stronger than assumed in the MPR in March. In isolation, this should pull the rate path downwards by 15-20bp.

• However, the appreciation of the NOK must be seen as a reaction to the rising oil price. After the May MPC meeting, the Board noted that ‘on the other hand, the rise in oil prices may reduce uncertainty and contribute

to somewhat higher growth in the Norwegian economy’.

• Hence, we expect NB to more or less net these effects, so that the overall effect on the rate path will be zero.

Source: Macrobond Financial, Norges Bank, Danske Bank Markets

The NOK is roughly 2.5 % stronger than NB’s forecast…

Source: Norges Bank, Danske Bank Markets

... but this is primarily due to a higher oil price


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 Analyst), Jostein Tvedt (Chief Analyst) and Kristoffer Kjær Lomholt (Analyst).

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