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Careful, Dull Norwegian Krone Grows More Attractive

Interest among hedge funds in the Norwegian krone has grown in the past few months. A precedent could be developing.

The Norwegian krone has conventionally been seen as a play on the oil price, given the country’s status as the largest producer in western Europe — and, by extension, as a play on the changing prospects of global economic growth.

Recently, however, a new reason to go long the krone has emerged. At a time when central bankers across much of Europe are trying to find ingenious ways of loosening monetary policy even further despite rock-bottom benchmark rates, Norges Bank has signaled that it will raise rates — consequently increasing the interest to be earned on krone bonds and deposits. Wednesday sees its next monetary policy meeting and, in the press statement and conference that will follow, important further clues to the country’s likely interest rate path. 

The story is unfolding very differently elsewhere in Europe, with developments in monetary policy over the past few years that were, only a few years before that, unimaginable.

The European Central Bank has flooded the euro zone with liquidity through two long-term refinancing operations (LTROs), which have played a part in weakening the euro by raising fears about inflation. The Bank of England has reduced its benchmark rate to the lowest in its 318-year history. In a bid to end capital inflows that will strengthen its currency, Denmark has followed the 2009 example of Sweden by creating a negative deposit rate, though Sweden’s has since returned to positive territory.

Compared with all this, Norges Bank has been positively dull. Although it cut rates rapidly in the immediate aftermath of the Lehman collapse of fall 2008, since 2009 it has merely tinkered at the edges with rates — with the last change in the policy rate, a 25 basis point reduction to 1.5 percent, made in March.

However, the next move looks more likely to be up than down. The June version of the central bank’s closely studied fan chart, which shows the probabilities of different rate scenarios, showed an upward revision in its assessment of the likely future path of interest rates that pointed to a rise early next year.

Looking at rival currencies, a hike in Norway’s benchmark rate would put it above Sweden’s, ending a key advantage for the Swedish krona —though it is one which Sweden’s central bank does not want. It would also raise the rate to a full percentage point above the European Central Bank’s and 125bp above the U.K.’s. A move by Norway to begin the process of monetary tightening long before the euro zone would give further impetus to the krone’s appreciation against the euro: a 7 percent increase over the past year that took it to €0.137 at the end of last week (Friday, August 24), or 7.3 krone to the euro. 

The pressure on Norway to hike interest rates derives from its buoyant economy with Thursday numbers showing gross domestic product (GDP) up 4.8 percent on the year in the second quarter. Norges Bank noted in the Executive Board’s June assessment that the strong economy was keeping unemployment low and pushing wage growth higher. Citing this and other common cost pressures in the report, it projected that Norway’s low underlying inflation rate — though still only 1.3 percent, according to the latest figures, for July — was likely to rise towards the bank’s inflation target of 2.5 percent.

Much of the growth comes directly from oil, with Norges Bank noting in the report that “growth in oil-related industries is vigorous.”

However, Norway’s underlying economic strength has been built up so carefully that even if it stopped producing any oil tomorrow, it would not suffer a fiscal crisis. As the euro zone imbroglio becomes ever harder to disentangle, the attraction of the krone lies not only in the oil or positive interest rate differentials, but also in the powerful fiscal buffers created by years of carefully husbanded oil revenue that make protracted periods of economic decline unlikely and debt crises virtually impossible to conceive. Gross government debt is projected at only 28 percent this year according to the Organization for Economic Cooperation and Development (OECD). With net debt of minus 167 percent — the most favorable figure of any of the OECD’s 34 members — Norway offers the rare double attraction of exposure to the commodity cycle and safe-haven status.

“Robust structural fundamentals,” including “the strength of its government finances,” have made the krone “an appealing destination for those seeking to diversify their holdings into other currencies,” says Daragh Maher, senior foreign exchange strategist at HSBC in London, which is forecasting a rise in the krone’s value to 7.10 to the euro at the end of the year. Bruno del Ama, chief executive of Global X Funds in New York, which manages a Norwegian equity exchange-traded fund, lists the fundamentals drawing money into krone investments as “a very strong macroeconomic environment, very low debt to GDP, very low unemployment, and a population that is one of the most educated in the world.”

This double attraction means, inevitably, that it is not as pure a commodity play as the Australian dollar, which is much more sensitive to commodity prices, or as strict a safe-haven play as the yen, which has regained much of its status as a refuge currency despite the Bank of Japan’s 2011 intervention. The krone’s broad appeal points to a long-term rise in value independent of the cycle of risk appetite and risk aversion, which governs the ups and downs of other assets and currencies.

Ed Lalanne, senior strategist at Macro Risk Advisors in New York, which works with hedge funds, says interest among clients in the Norwegian krone has grown in the past few months. Asked why appetite for the krone as a safe haven was muted before, he says: “A lot of things like this have to do with precedent. There’s a big precedent nowadays to go into Germany as a safe haven. There’s really no precedent to go into Norway. But there’s every reason why there should be a new precedent.”

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