Posted on Friday, 18th March 2011 by Charlotte W
Norges Bank held its key policy rate unchanged at 2% as widely expected. However, the projected interest rate path for 2012 – 2014 was increased significantly compared to the October Monetary Policy Report (MPR) (see chart 1 on next page). While we had expected the rate path to be revised upward, this was more than we had anticipated. The rate path was increased by 29bp in 2012 and 44bp in 2013 (annual averages).
The central bank signalled that the key rate should be between 1.75% and 2.75% until the next Monetary Policy Report on 22 June unless the Norwegian economy is exposed to major new shocks. Norges Bank states that the policy rate “should be increased before the end of the first half year.” This means that the bank intends to raise the policy rate by 25bp either in May or June. We believe the first hike will probably occur in May though they may defer till June. Further, Norges Bank is signalling hikes totalling 75bp by the end of this year and an additional 125bp during 2012 taking the key policy rate to 4% by end-2012.
The main reasons for raising the rate path are as follows: 1) interest rate expectations abroad have increased; 2) mainland demand and GDP growth are higher; and 3) prices and costs will rise from 2012. Conversely, a stronger nominal exchange rate in isolation has depressed interest rates, as have lower core inflation and higher than expected risk premia in money market rates.
Moreover, it is also interesting to observe a technical model suggesting that rates should be set lower in coming months due to recent slower than anticipated underlying inflation. However, Norges Bank have found it unnecessary to reduce rates before raising them again later this year and therefore uses the term “interest rate smoothing” to explain why the rate path has not been lowered over the next few months. We believe “rate smoothing” should be considered in conjunction with the need to guard against the risk of future financial imbalances. This consideration now suggests, say Norges Bank, that the policy rate should be increased in the near term. The bank was vaguer on the subject back in January.
Market reaction: Front FRA contracts up 3-5bp, red contracts 6-8bp. EUR/NOK from 7.90 to 7.87 but back again later. Market reaction muted with all eyes on Japan.
Conclusion
With the new signals from Norges Bank broadly in line with our earlier assessments, we see no need to revise our forecasts significantly. We expect the bank to hike rates by 25bp in May with a possibility they may defer till June. Further, the rate will be raised twice more in the second half (see table). We adjust our end-2012 forecast upward by 25bp.
Our rate path is now very similar to Norges Bank’s own projections, the only difference being that they seem to forecast a second hike in October rather than September.
Current market pricing indicates significantly lower policy rates and 3-month money market rates than either we or Norges Bank project (see chart 2).
Similar Posts:
- ECB Rate Decision and Impact on EUR
- ECB to Leave Rates Unchanged for Rest of the Yr? RBA to Cut?
- ECB preview: Decoding a July hike, “Very close monitoring”
- Canada: no choice but to raise rates
- We expect FOMC to raise rates in 3Q11
Tags: Bank, Norges Bank
Posted in Business Quotes | No Comments »