The sustained NOK weakness over the past year is a puzzle. In this piece we take a look at the FX economics of the NOK to see if we can find an explanation.
We argue that part of the NOK weakness is fundamentally unjustified. A global reflationary shock could be a key trigger for NOK revival; the opposite of 2013.
In the case of a lack of negative external demand and offshore shocks, however, the NOK would still have to strengthen for Norges Bank to fulfil its inflation target. We consequently expect NOK strength to materialise over the coming 12M.
Why is the NOK so weak? From investors and corporates to policy makers this has become a puzzle. SSB (Statistics Norway) has given up on forecasting the NOK and now assumes an unchanged NOK in its economic outlook, the latest here .
Furthermore, in its last monetary policy report Norges Bank (NB) lowered its estimated long-term equilibrium NOK exchange rate without providing an explanation for the sudden change other than 'in the light of new data '. As the NOK has been consistently weaker than expected by the central bank over the past years, our guess is that the usual explanation of an 'elevated risk premium' was no longer satisfactory. NB mentioned that the deterioration in terms of trade from the 2014 oil price drop could have had a more pronounced negative effect than previously modelled via its NEMO-model. While this very likely entails an element of truth, the explanation still does not explain why the currency only recently has decoupled from its historical drivers (Chart 1).
It is important to emphasise that we have also been surprised by how the NOK has failed to gain terrain over the last year despite higher oil and NB rate hikes beating market pricing. In this piece we take a look at the FX economics of the NOK (Chart 2) and will explain why we still expect the NOK to strengthen over the coming year in the absence of external shocks and/or a collapse in the oil price.
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