Norway: rate hike on strong growth outlook

Macro: most likely a 19 September target rate hike.

Fixed income: higher Red FRAs on Norges Bank – risk related to ECB's two tier system.

FX: tactically stay short EUR/NOK.

New trades: buy Red FRAs on expectations of a Norges Bank hike and improved international sentiment (conditional). Sell NST481 (10-year benchmark) versus swap. Sell EUR/NOK spot outright (from 9 September).

Closed trades: no closed trades.

Domestic growth counteracts global turmoil

We expect Norges Bank to raise the key interest rate by 0.25pp to 1.50% at the monetary policy meeting on 19 September. This was strongly signalled by Norges Bank in the monetary policy report in June. However, the escalation of the US/China trade war and the gridlock in the Brexit negotiations have increased downside risks from the global economy. However, as (i) the domestic economy still seems insulated from the global slowdown and (ii) the NOK is unaffected by the rising spreads versus global rates, we expect Norges Bank to hike rates as planned.

In June, the rate path indicated around 70-75% probability that interest rates would rise again in September. Since then, global forward rates have fallen significantly and global growth prospects have weakened. This will push the rate path downwards but especially from end-2020. However, the NOK has been weakened on global risks, even though the oil price has been more or less in line with expectations. The net effect on the rate path from financial factors (rates, FX, oil price) is actually positive in the short end, indicating two hikes within March and then lower from mid-2021 and indicating a rate cut in 2022.

Domestic growth appears to have been roughly as expected and the Regional Network survey points to an annualised growth around 2.7% for the next six months. However, core inflation has been weaker than expected, which in isolation will pull the rate path downwards marginally.

As financial factors point to two rate hikes and domestic growth has been as expected, it takes a significant downward revision of the global outlook for Norges Bank to signal ‘on hold' for the entire period. We expect Norges Bank to make downward revisions to the global outlook but any expectations of Norges Bank calling a global recession at this point seems highly premature. We acknowledge Norges Bank could change the risk assessment and stay on the sidelines due to increasing downside risks. However, as the policy rate still is well below the neutral rate, we find it hard to believe that it will stay on hold for almost a year awaiting a possible global recession. As a result, we expect Norges Bank to stick to its plan and hike rates and believe that the new rate path will indicate a small probability of another rate hike (around 25 %) in the first half of 2020 and then flatten. Importantly, this would signal a higher probability of a rate hike than a rate cut going forward.

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