The Norwegian central bank’s decision to fight krone gains with interest rate cuts may invite speculators to test policy makers’ resolve to weaken the currency.
“I am a bit shocked,” Olav Chen, a senior portfolio manager who oversees about $7 billion at Storebrand Asset Management in Oslo, said in an interview. “There was complete miscommunication before the meeting.” The bank “clearly has a threshold and that could pave the way for speculative attacks to find out where that threshold is,” he said.
Governor Oeystein Olsen showed yesterday he won’t tolerate further krone appreciation by cutting the overnight deposit rate a quarter of a percentage point to 1.5 percent, when most economists surveyed by Bloomberg predicted no change. The decision follows the currency’s ascent to a nine-year high against the euro earlier this month after investors turned to Norway’s oil-backed markets to hedge against Europe’s debt crisis.
“There is no doubt that there has been significant strengthening of the krone,” Olsen said in an interview yesterday. “That is an important element and factor at this occasion.”
Olsen’s decision to cut rates sent the krone plunging the most since May 2010. Norway’s currency lost as much as 1.9 percent against the euro to 7.5976 and slumped as much as 2.4 percent versus the dollar to 5.8352 yesterday.
Still, the krone gained today, signaling the exchange rate effect of monetary easing may be short-lived. The krone appreciated 0.1 percent versus the euro to trade at 7.5830 as of 10:18 a.m. in Oslo. Against the dollar, the krone gained 0.3 percent to 5.8079.
Olsen said the bank doesn’t defend a specific krone level and that interest rate policy will only respond to the exchange rate to the extent that it affects the inflation outlook.
“We have no intention of entering any dialogue or game towards the currency market at all,” Olsen said. “We have stressed several times that we have no certain level. But this time we have clarified that we will react on variables that affect our targets.”
The bank signaled yesterday it intends to keep its benchmark interest rate unchanged for a year. Underlying inflation, which adjusts for taxes and energy, will remain below the bank’s 2.5 percent target through 2015, it said. Inflation by that measure held at 1.3 percent in February, and has been below target since August 2009.
Oil, Not Rates
Olsen’s efforts to contain the currency of the world’s seventh-largest oil exporter through rate cuts may ultimately fail, according to Kyrre Aamdal, a senior economist at DNB ASA, Norway’s biggest bank based in Oslo. He says the krone’s strength is driven more by the price of oil than by interest rates.
“We have seen that the correlation between interest rate differentials and the Norwegian krone has not been very strong recently and we think the reason for the very strong krone is the high oil prices,” Aamdal said by phone. “We are a bit skeptical as to whether this was a good move.”
The bank’s decision to focus more on the currency market than the threat of a credit-driven housing bubble may also prove dangerous, according to Aamdal. The Financial Supervisory Authority warned this week that the biggest domestic threat to Norway’s economy stems from an overheated property market as borrowers assume interest rates will stay low.
At Norges Bank, Olsen said policy makers “don’t use the word bubble,” in yesterday’s interview. “We think we are not close to a bubble in the housing market, in the classical sense.”
Robert Shiller, the co-creator of the S&P/Case-Shiller home-price index, in January warned Norway is already in the grip of a house price bubble that could be “dangerous” for the economy.
Private debt levels have swelled to the highest level since at least 1988, the central bank estimates, while house prices rose an annual 7 percent last month, according to the Real Estate Brokers Association.
“We think the domestic economy needs higher interest rates,” Aamdal said.
The central bank has stepped up its efforts to counter the krone’s appreciation since the Swiss National Bank in September clamped down on currency speculation by pegging the franc to the euro. That sent investors in search of alternative havens from Europe’s debt crisis.
“Let’s not hope Norway will be another Switzerland,” said John Hydeskov, chief analyst at Danske Bank A/S in London, in an e-mailed reply to questions. “Norges Bank knows perfectly well that a 25 basis point cut won’t curb the appreciation of the krone by much. A rate cut signals: ‘We are alert.’ They hope the symbolic value is enough.”
Before yesterday’s rate cut, the krone was the fourth best-performing major currency against the euro and the dollar this year, gaining 3.8 percent and 4.7 percent, respectively.
“The rally in the krone has been a major headache,” said Chen at Storebrand. “I find Mr. Olsen very unclear. If central banks seek transparency and to be good at guiding markets, they have failed.”