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Preview Norges Bank: Will the Board discuss a rate hike on Wednesday?

Mon, Sep 21 2009, 14:15 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S  |  View company's profile

At its last rate-setting meeting on 12 August, Norges Bank signalled that rate increases could come quicker than assumed in the interest rate path in its June monetary policy report. Together with changes in interest rate expectations elsewhere in the world, this has altered the market’s expectations for interest rates in Norway.

Growth indicators consistently exceeded expectations during the summer, and the risk of a fresh downturn seems to have been reduced. Capital markets are functioning almost normally again, and confidence is returning to both households and businesses. On the other hand, inflation has continued to fall – albeit seemingly without any imminent risk of deflation.

Growth in Norway is still too weak to stop unemployment from rising, and industrial orders are falling so fast that order books are rapidly emptying. This may also be a reason for the sharp fall in the PMI in August. Uncertainty about the short-term outlook for the oil supply sector has therefore increased somewhat.

All in all, there is little doubt that the upward revision of interest rate expectations is justifiable. In its June monetary policy report, Norges Bank envisaged a first hike in “late winter”, which most interpreted as meaning at the April meeting. The fact that the bank found it necessary to change course just two months later at the August rate-setting meeting suggests that we are not talking about the first hike being brought forward by just one or two meetings – in all probability we are looking at a rate increase this side of Christmas.

We think that a hike at this week’s meeting would be on the early side, though. Since Norges Bank altered course, several western central banks (Fed, ECB, Riksbank, BoE) have given fresh assurances that interest rates will remain low for a long time to come.

The meeting may nevertheless reveal whether Norges Bank expects to move in October or December. The clearest way of signalling this would be to say that “an increase in the interest rate was discussed at the meeting”. However, given the major change in Norges Bank’s risk assessment since June, we reckon that the most appropriate line would be to stake out the new course and present a new interest rate path in the next monetary policy report in October, and then actually raise interest rates in December. On the other hand, it could be argued that if the bank has already decided that interest rates are to go up, it might as well go ahead and put them up at the October meeting.

What actually happens depends on Norges Bank’s assessment of the risk outlook and how precarious it believes growth and inflationary pressures to be. Wednesday will bring an answer. Either way, it has to be assumed that we are looking at a long period during which interest rates will rise significantly.

Currency implications

Norges Bank is expected to confirm at the coming week’s rate-setting meeting that the Norwegians are looking at a period of rising interest rates. In isolation, this will tend to strengthen NOK. On the other hand, some market participants may be disappointed partly by the bank’s key rate not being raised straight away and partly by the bank not issuing a totally unambiguous signal to the market that the key rate will go up in October. Whether the sentence “an increase in the interest rate was discussed” is included or not will be crucial for the FX market. If NOK does depreciate following the meeting, we would see this as a clear opportunity to take a long NOK position. Interest rate differentials are also gradually beginning to count in NOK’s favour. As before, we expect Norges Bank and the Reserve Bank of Australia to be the first G10 central banks to raise their rates.

Fixed Income implications

The lack of a hike on Wednesday is likely to disappoint the market somewhat, and we expect the FRA curve to steepen. The impact on longer rates will depend on the wording of the statement. A repeat of the wording from the August meeting will probably have little impact. A reference to a discussion about a rate hike will lead to higher long rates and a flatter rate curve.

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Published on  Mon, Sep 21 2009, 14:22 GMT

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