NOK to remain under pressure as long as Norges Bank remains expansionary

The credibility of the Norwegian central bank is at stake. This is because the longer the pace of inflation moves above the target, it becomes more difficult of the Norges Bank to convey to the market that its easy monetary policy is effective and it still has inflation in control, said Commerzbank in a research note. The pace of inflation currently is above the target rate by nearly 2 percentage points.

As long as the Norwegian central bank continues to be expansionary, the trend in the pace of inflation is not expected to reverse. Particularly, an additional reduction in rate might counterproductive in the end and might even quicken the inflation trend.

However, it is more significant to the central bank to underpin economic growth against the backdrop of the continuous low oil price and declining investments in the oil and gas sector. Thus, despite the inflation trend, the central bank is expected to stick to its expansionary monetary policy for now, possibly cut the key rate once again by the end of 2016, stated Commerzbank. Consequently, the Norwegian krone would weaken against the euro.

This weakening of NOK would proceed gradually as the market still assumes that the Norges Bank is ready to undertake action against excessive inflation rates at certain point.

“If the market distances itself from this view, Norges Bank risks a massive selling wave in the NOK and further upside pressure on inflation”, according to Commerzbank.

Thus, at one point the central bank would have to tighten its monetary policy to keep its credibility in the market as long as the inflation trend continues to be high. The Norwegian krone would remain under pressure as long as the central bank continues to be expansionary.

Meanwhile, the USD/NOK exchange rate is influenced by the central bank’s policy and also by the slow normalization of the US monetary policy. Thus, an upside potential is likely in the USD/NOK pair in the months ahead.