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NOK expected to strengthen as preparation for a Norges bank rate hike begins

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The Norwegian central bank held its monetary policy meeting last week. As expected, interest rates were left unchanged at 0.50%. The central bank however, lifted the rate path which was in line with market expectations.

“The outlook for the Norwegian economy suggests that it will soon be appropriate to raise the key policy rate,” the central bank said in its monetary policy statement.

The improving Norwegian economy and closing of the output gap underlined the hawkish outcome from the Norges bank meeting. The central bank sounded more hawkish as the likelihood of a Norges bank rate hike in September increased.

Given that the central bank signaled at the December monetary policy meeting that it preferred a growth oriented policy, the markets were leaning towards hawkish forward guidance, hinting at potential interest rate hikes in the future.

The central bank confirmed this view at the meeting in March. It noted that “Economic growth appears to be somewhat stronger than expected, and the output gap for Norway is closing. Underlying inflation is low, but rising capacity utilization will probably push up price and wage inflation further out.”

The adjustment to the short end path was larger than expected, with the probability of a Norges bank rate hike standing near 80% for September. Furthermore, expectations for an earlier rate hike also increased. For June, the probability rose to 20% and 36% for August.

Supporting the Norges bank rate hike was the fact that the overall macro and financial developments showed a larger than expected revision to the rate path. The central bank said that the uncertainty surrounding the effects of its monetary policy suggested a cautious approach.

Despite the increase in the rate hike expectations, the number of rate hikes is expected to remain unchanged. The Norges Bank’s rate path suggested that there will be two rate hikes in 2019 and two more rate hikes in 2020.

Norwegian housing prices continue to remain a concern, but this has been  improving. The central bank lifted its forecast for existing home prices to a modest 0.7% decline this year but expects housing prices to rise 2.0% in 2019.

“Household credit growth remains high, but over time lower house price inflation will dampen debt growth,” the central bank said about the home prices. However, a faster than expected increase in home prices could potentially push the Norges bank towards a faster pace of rate hikes.

About inflation, the Norges Bank was seen lowering its short term and long term inflation expectations. The near term inflation forecasts were lowered as the central bank forecasts CPI to average around 1.5% on a year over year basis in March and 1.6% on a year over year basis in April.

Consumer prices are expected to remain somewhat subdued largely on account of a stronger NOK exchange rate and weaker pace of wage growth.

The effects of the monetary policy is expected to weigh on the trade weighted NOK as well. The forecasts for the NOK were revised slightly higher. The central bank expects a gradual strengthening of the Norwegian Krone which is expected to rise 2.0% until Q1 of 2018 and is then expected to rise 3.9% by 2020.

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