Norges Bank should ignore the NOK

At this time, monetary policy can disregard consequences for the krone exchange rate

Given the global outlook and expected structural capital outflows from Norway, a policy rate at today's level is of little help to the krone exchange rate. The interest rate will probably have to rise by 0.75 to 1.25 ppts for the krone to get a boost of 5-10 per cent. But the harmful effects of this would probably be significant. As such, Norges Bank should set policy rate without considering any consequences for the krone exchange rate.

The policy rate in Norway has been kept unchanged at 4.50% since December 2023. Since then, core inflation has fallen from 5.5% to 2.7% and therefore many people are asking: why wait until March?

I think there are two reasons: one is that the Norges Bank Governor Ida Wolden Bache likes to “play by the book,” meaning that she likes any changes in monetary policy to be based on thorough assessments and projections from the Monetary Policy Department, a department she previously headed.

Another reason may be that Norges Bank wants to see what early measures the new US administration comes up with, and in particular whether these will have a material impact on the dollar exchange rate and US interest rates. In that case, this will affect the krone exchange rate and may also have consequences for the policy rate.

Policy can be better argued in March than two days after the inauguration of the US president. Hence Norges Bank stayed on hold this week.

But there was another strong indication of a cut in March, as was also given in December.

I read it almost as binding. Since December inflation was lower than Norges Bank had projected for the month, disappointing Norwegian macro figures would have to emerge over the next two months (which I see as quite unlikely) – or – that the world looks “ugly” two months into Trump's presidency (depending on the eyes that see), for such a cut not to take place.

The fact that interest rates are somewhat higher today among our trading partners than a few weeks ago is probably not a good enough reason to stop a cut in March.

I'm more focused on whether there will be more cuts for the rest of the year. I have had one more cut in mind for a long time, and then in the September meeting. The alternative is that the March cut will be the only one this year, and I see that forecast as almost as likely as the main thesis.

In the discussion about the weak krone exchange rate, many have argued that the krone needs a positive interest rate differential against several currencies. Historically, one can possibly find evidence for this, but for several time periods, I am of the opinion that other parameters have had a greater significance.

I feel that we are in such a period now, that we have been there for some time, but more importantly, that there are completely different parameters that will determine the strength of the krone in the years to come, and that Norges Bank's policy rate will probably have little impact on the krone exchange rate.

Norges Bank appears to believe—or perhaps hope—that a widening interest rate differential against trading partners will support the krone exchange rate, and the Monetary Policy Committee will therefore give weight to the consideration of the krone exchange rate when setting the policy rate. I believe today that this is not correct. If the policy rate were to help, it would probably have to be raised 0.75 to 1.25 percent. This will not benefit Norway.

I would emphasise instead:

• that Norwegians, like several others, will continue with massive investments in US equities and bonds. Stocks because Trump probably sees the stock market as the best gauge of temperature for his economic policy and bonds because you get paid very well;

• low willingness to invest among foreigners in Norway, especially for the void left by lower oil and gas investment and the fact that there is a lack of new ambitious projects;

• growth in world trade is threatened by increased use of tariffs and protectionism, which may hamper Norwegian exports and make imports more expensive;

• the general geopolitical situation, which I see as worrying, to say the least.

These will be the drivers of the NOK.

I have previously noted the structural capital flows from Norway and associated seasonality. We are in a quarter where these normally support the krone exchange rate. So far, that has not happened. If this does not happen through the rest of the winter, the second half of the year could be a major challenge for the krone. This is because structural capital flows have historically been very negative through the autumn.

If I add threats of tariffs, protectionism and the increased geopolitical tension that may arise as a result of these, there is a considerable downside risk for the krone exchange rate. Against this background, I believe that the policy rate at the current level has no chance as a defense for the currency. If it is to be of help, it must be set significantly higher, and it should not be.

In my opinion, the policy rate should therefore be set without considering the impact it will have on the krone.

The reason is that the fate of the krone in the foreseeable future will be determined by completely different parameters. If Norges Bank needs help from the krone exchange rate, completely different measures must be used.

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