Norges Bank Review: On hold, strong tightening bias

As widely expected, Norges Bank (NB) this morning kept policy rates unchanged at 0.75%. Also as expected, the rate path was adjusted moderately downwards on global events and a lower oil price. Still, NB clearly signalled that the next rate hike should be expected in March 2019.

'The Executive Board's current assessment of the outlook and balance of risks suggests that the policy rate will most likely be raised in March 2019.'

The rate path published in the Monetary Policy Report (MPR) was adjusted downwards from Q4 19 and throughout 2021. Specifically, the rate path indicates that the next hike will come in March 2019, and the next one most probably in September. Further out the rate path signals slightly less than two hikes in 2021, i.e. roughly five hikes for the next three years.

The factors affecting the rate path were broadly in line with our expectations. Global risks and global forward rates pushed the rate path downwards. Lower oil prices pulled in the same direction. On the other hand, a weaker currency more or less counteracted this effect. Moderately higher inflation and domestic growth also pulled the rate path marginally upwards. Also, according to NB, the uncertainty surrounding the effects of changes in interest rates when rates are close to zero still calls for a more careful approach.

As we expect the global expansion to continue, we still expect NB to hike rates again in March, and deliver another rate hike in H2 19 (likely September).

FI/Rates. Market interest rates increased marginally at the short end on the MPR 4/18, despite NB's marginal downward revision of the rate paths. That said, market forward interest rates are still significantly lower than NB's interest rate projection.

Our short-end strategies have in recent months been for higher short-term interest rates both in absolute terms and relative to international peers. The oil led upswing in Norwegian economic activity has been confirmed lately by the regional network report and the recent monthly mainland GDP data. In light of today's MPR 4/18 we reiterate the recommendation for higher market interest rates at the short end. In the 10 December Reading the Markets Norway we suggested buying NOK 3M FRA JUN19 outright or vs MAR19 ahead of the NB meeting. At the time the market only discounted a NOK FRA 3m MAR19 at 2.5bp lower than the JUN19 contract. Immediately after the release of MPR 4/18 the spread was 4bp. NB's projection for the 3m Nibor in Q2 is 1.41bp (1bp higher than in the MPR 3/18 report) and in Q3 1.56bp (unchanged), i.e. a curve steepness Q2 - Q3 of 10bp. We expect market interest rates in 2019 to increase according to NB's projections - or more.

We have at present open a few outright strategies for higher interest rates, including paying NOK IRS 2Y/2Y outright. Given the current international economic and political turmoil the outright strategies are risky compared to relative strategies. However, note that the current risk-off environment related to Italy, France and Brexit seems to harm the market's risk appetite for Norwegian fixed income, i.e. affecting the risk related to relative strategies.

FX . EUR/NOK has fallen three figures at the time of writing. In our view the very near-term potential is limited given the global risk environment and investor focus on year-end seasonality. That said, we think today's decision underpins the NOK attractiveness from a 2019 perspective and supports our case for gradually building NOK longs in the coming weeks. We remains short EUR/NOK (3M seagull) and long NOK/SEK spot outright.

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