David Bloom, global head of FX strategy at HSBC, says the leeway for the Norges Bank to manipulate its currency through the interest-rate channel is becoming constrained as the policy rate approaches zero. “The NOK enjoys understandable support, capitalizing on its strong economic fundamentals,” he says. “Economic growth in 2012 is expected to outpace most of G10, while oil-related revenues will continue to ensure a healthy external balance and strong public finances.
“In a world where AAA-rated investments are becoming rarer, Norway’s currency stands out as an attractive prospect, its allure as a reserve currency limited only by its diminutive trading volumes.”
The Norges Bank has had some success in using interest rates to undermine the NOK and fight deflationary forces within the Norwegian economy, but Bloom says there must be some doubt as to its potency beyond the initial announcement effect.
Indeed, the Norges Bank’s 50 basis points rate cut in December generated some initial NOK weakness, but this reversed in subsequent months, encouraging a further 25bp cut in March. It is still too early to say how durable the impact will be on this occasion, though many believe further strength is imminent.
| Rate cuts provide temporary relief for NOK |
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| Source: Bloomberg, HSBC |
In any case, further rate cuts risk generating collateral damage elsewhere in the economy by fuelling the credit and housing market boom that could unravel in a destabilizing way, says Bloom.
Low interest rates have insulated the Norwegian household sector, allowing a rise in Norwegian private sector debt that has helped fuel a boom in house prices, which has long been flagged as a concern by the central bank.
Indeed, household debt continues to climb substantially quicker than disposable income, and the Norges bank expects this process to continue.
| Norwegian household debt burden continues to rise |
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| Source: Norges Bank, HSBC |
Bloom says an alternative to lowering rates would be for the Norges Bank to mimic the strategy of the SNB and impose a floor on EURNOK.
He adds that if maintaining the floor were to require sterilized direct intervention and the accumulation of foreign exchange reserves, this would not be something new for the Norwegian economy.
“It has happily built up foreign assets courtesy of its oil sector through its sizeable NOK3,400 billion (USD600 billion) sovereign wealth fund, the Government Pension Fund Global (GPFG), and has the infrastructure and expertise in place to manage any additional increase in assets that FX intervention might generate,” says Bloom.
He says that by directly targeting the NOK in the FX market, rather than indirectly targeting the currency in the interest market, the Norges Bank would have the advantage of precedent on two fronts.
“The success, so far, of the SNB’s policy would lend credibility to any equivalent policy in Norway,” says Bloom.
“In addition, the small size of the NOK market would make it unlikely to face international wrath for currency manipulation, in the same way as the international response to the SNB policy shift was muted.”