The revised rate path has a 100% implied probability of another 25bp rate cut in 2016 and a 20% probability of an additional cut to zero in H1 17. Conditioned on no policy changes in May, the Q2 16 average suggests a 50% probability of a rate cut in June 2016. Given the rest of the rate path, this seems like a reasonable condition.
We notice that while Norges Bank states that the lower bound on rates is below zero, the threshold for going to NIRP seems relatively high.
Market reaction : Prior to the decision, markets had priced in around 80% probability of a rate cut today. Post the decision, short-term rates have fallen and markets are now pricing in more than a full rate cut on a 12M horizon with a high probability of a cut before Q4. EUR/NOK saw a knee-jerk reaction lower on the back of a 'lower bound' comment but has since risen to levels higher than before the announcement.
Our expectation : Overall, the rate path was a bit more dovish than we expected and highlights a determination to expand monetary policy further given the current outlook. As a result, we now expect Norges Bank to cut rates again in June, to 0.25% . Given our own projections at this point in time, which are less pessimistic than Norges Banks, we expect June to mark the bottom in the sight deposit rate.
FX : While the NOK from a medium- to long-term perspective is undervalued, the short-term outlook continues to be closely tied to global risk appetite both directly (via the EUR's status as a preferred funding currency) and indirectly (via global growth expectations and oil prices). While the NOK is fundamentally undervalued, we maintain the view that we will have to wait until H2 before we see a more sustainable appreciation trend materialise.
Fixed income : The lack of openness illustrates that a strong NOK is just what the central bank fears. Given the short-term risk of negative rates in a strong NOK scenario, the FRA curve 2017 to 2019 should be steeper than projected by Norges Bank, i.e. the current market seems to be fairly prices.
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