Norges Bank to revise down rate path significantly and cut rates

This week Norges Bank will publish its rate decision and a new rate path. The market forecasts a higher possibility of the central bank lower rates to 0.5% from 0.75%. The rate path of central bank from December held more than 50% chance for a rate cut in March and bottomed out at 0.39% late 2016. Since December, almost all news argues for lower of rate during the central bank’s meeting in March. The rate path is very much expected to be lowered too.

Expected interest rates outside of Norway have declined considerably, and the central bank has always cut its rate forecast when expected rates abroad have declined. Spot oil prices have again reached the same levels seen in December, but forward prices for the end of forecast horizons (2018) is still 12% lower. According to Norges Bank, decisions regarding oil investment are largely based on forward prices. Because of decline in oil prices, the central bank cut its rate path considerably through 2015.

Mainland growth through 2015 was slower than expectations and the central bank’s own business surveys indicated weaker growth in Q1 2016 also. This suggests that the mainland GDP growth is around 0.5% lower than projections. However, the impact on the rate path should be dampened as the other measures for the output gap such as unemployment has developed in line with expectations.

Wage settlement in 2016 is expected to be based on a projection for CPI at 2.5%. Unions demand for unchanged real wages, which indicates wage growth of 2.5%, below the central bank’s forecast of 2.75%. Lower wage growth has always argued for a lower rate path. Meanwhile, money market spreads are above expectations, also arguing for lower key rates.

The only argument for higher rates is the core inflation figure for February. Core inflation was 0.3 percentage points more than Norges Bank’s projections. However, 0.1-0.2 percentage points of that was because of airfares increasing due to winter holiday. This is expected to be reversed in March. Hence, the impact on rate path should be small.

“We believe the bottom in the rate path will be lowered to close to 0.2 % late 2016. We also believe the rate path will signal a more than 50% chance for a cut already at the June meeting to 0.25%. We estimate premiums to be 45 bp, which indicate that 80% is priced in today’s 3M Nibor. That means the cut in itself should be somewhat dovish”, says Nordea Bank.

A fairly dovish rate path is expected. Therefore all short rates will fall and the NOK will weaken.