European monetary policy and FX roundup

Summary

It has been a particularly busy week across Europe, with several of the G10 centralbanks making monetary policy announcements and contributing to varying degreesof market excitement. In this report we briefiy recap these announcements and assesstheir FX implications.

Norway's central bank became the first G10 central bank to raise rates with a 25 bpsrate hike as the economy returns to a more normal growth path. While the centralbank's projections signaled further rate hikes, the increases penciled in for 2022 stilllook a touch light to us. We see upside risk to our current forecast of Norwegian kroneappreciation.

The Bank of England held monetary policy steady and, despite cross-currents afiecting the U.K. economy, said the case for modest tightening has potentially strengthened.With the announcement we have brought forward our expected timing for rateincreases, and we now expect the Bank of England to initiate a rate hike cycle withan increase in May 2022, followed by November 2022. While the pound may besubject to some near-term uncertainties, we expect the U.K. currency to strengthenagainst the U.S dollar and the euro over the medium-term.

Sweden's central bank and Switzerland's central bank both held monetary policysteady, with no indication either central bank will move to a less accommodativemonetary policy stance for the foreseeable future. Given the strength of Sweden'seconomic rebound we still anticipate modest Swedish krona strength versus theeuro. For Switzerland, moderate Swiss growth and infiation, combination with someimprovement in global economic and market sentiment over time, should see thefranc soften versus the euro.

Norway's central bank kicks off G10 rate hike cycle

The Norges Bank, Norway's central bank, became the first developed economy central bankto raise interest rates during the current cycle, lifting its Deposit rate by 25fv bps to 0.25%.The move was widely expected by market participants, and was justified by the centralbank on the back of firming growth rather than infiation concerns per se. The NorgesBank said a "normalising economy now suggests that it is appropriate to begin a gradualnormalisation of the policy rate", and added that while underlying infiation is low increasedactivity and rising wages should push it towards 2%.

The Norges Bank's updated projections anticipate further normalization of the economy,with the mainland GDP growth forecast at 3.9% for 2021 (versus 3.8% previously) and4.5% for 2022 (4.1% previously). The interest rate path contained within those projectionsis also slightly higher than previously. In its announcement, the Norges Bank explicitlystated the policy rate would most likely be raised further in December, while the revisedrate path sees the policy rate rising to 1.12% by Q4-2022. We are in agreement on aDecember 2021 rate increase. However, given we also expect a solid ongoing economicrebound, the rate path for next year still appears to be a touch light. We expect at leasta further 75 bps of rate increase, and perhaps as much as 100 bps of rate increase, in2022. Against this growth and monetary policy backdrop we believe the risks around ourNorwegian krone forecast are tilted towards a faster pace of appreciation relative to ourbase case, which anticipated a EUR/NOK exchange rate of NOK9.95 by the end of nextyear.

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