Economic fundamentals decline.
Earlier last week, Norges Bank lowered its deposit rates to an historic low of 0.50% from 0.75%. The Norwegian central bank is trying to foster growth in a country where a quarter of its economy depends on the oil industry. In 2015, the GDP printed at 1% y/y, down from 2.3% the previous year, mostly due to the decrease in investments. However, consumer spending and exports improved last year, both increasing 2% and 2.6% respectively. Unemployment is on the rise and even though it remains relatively low, it has jumped from 3.5% in 2014 to 4.4% in 2016. Wage growth is expected to suffer. Declining economic conditions have been sufficient to convince Norges Bank to cut rates in order to import inflation and becomes more competitive.
Domestic risks are important.
The main issue in this competitive devaluation is that the ECB and Sweden are following the same monetary policy. The ECB is clearly trying to further devalue the single currency and Sweden has already adopted negative rates. Competitive devaluation is pushing Norges bank to maintain the stance of its monetary policy accommodative. In addition, the end of low oil prices would have the adverse effect to strengthening the Norwegian currency. We consider that this strategy of entering into competitive devaluation is not without risk as it could damage price stability. Indeed inflation is far from being weak – 2015 CPI printed at 3.1% y/y. Hence, Norges Bank is willing to increase upside inflation risks which would remove the increased competitiveness earned from a lower Krone. Last but not least, low rates could underpin a real estate bubble.
Negative interest rates are on target.
The Norwegian economy’s outlook is clearly uncertain. There is the need to increase competitiveness by devaluing the currency to increase growth and revenues as Europe and Sweden’s monetary policy in particular are so aggressive as negative rates are still in place. In other words, Norway is currently taking a bet of sacrificing price stability for the sake of competitiveness.