Norwegian inflation validates our Krona valuation
Norwegian inflation slowed more sharply than Norges Bank expected in June, weakening the case for another rate hike and pushing EURNOK towards our near-term forecast.
Headline CPI fell from 3.1% to 2.7% year-on-year, while prices declined by 0.2% on the month. This was well below Norges Bank’s 3.2% projection. EURNOK consequently moved from around 11.1 towards 11.2, bringing our one-month forecast of 11.3 firmly into view.
Before today’s release, the case for further tightening rested on persistent domestic inflation. CPI-ATE stood at 3.4% in May, wage growth is expected to remain around 4.5%, and Norges Bank has repeatedly highlighted the inflationary impact of rising business costs.
The Bank raised the policy rate to 4.25% in May and held it there in June, but signalled that another hike would probably be required. Its projected rate path pointed to a policy rate just above 4.5% by year-end.
Today’s release challenges that view. Headline inflation is now half a percentage point below the Bank’s June projection, giving policymakers greater scope to avoid restricting the economy more than necessary. Admittedly, Statistics Norway was unable to publish CPI-ATE because of technical problems, meaning it is still too early to conclude that underlying inflation pressures have eased materially. Even so, the burden of proof has shifted.
Norges Bank now needs renewed evidence of sticky core inflation to justify another hike, rather than merely relying on the assumption that price pressures will remain elevated.
The FX reaction fits our existing forecast profile almost exactly. We expected NOK to weaken initially as falling oil prices removed its geopolitical tailwind and markets questioned whether Norges Bank would deliver further tightening. The move in EURNOK towards 11.2 is therefore not a reason to revise our outlook. It is the first stage of the path we anticipated.
We retain our forecast for EURNOK to trade towards 11.3 over one month and around 11.2 over three months.
Beyond that, we continue to expect a gradual NOK recovery, with EURNOK moving towards 11.1 over six months and 11.0 over twelve months. Norges Bank policy remains restrictive even without another hike, while NOK remains undervalued in our view. Softer inflation strengthens our near-term call but does not alter the expected medium-term reversal.