Norway: Lower FX purchases suggest appetite for stronger NOK

Norges Bank (NB) announced daily FX purchases data for the month of December today, and for the second consecutive month, surprised on the downside. Daily purchases were trimmed from NOK4.3bn to NOK3.7bn in November, and will be further cut to NOK1.9bn next month. December’s FX operations will be carried out only until the 16th.

For context, Norges Bank conducts FX operations on behalf of the Ministry of Finance, converting NOK excess petroleum revenues (after financing the budget deficit) into foreign currency holdings, which are then saved in the Government Pension Fund Global (GPFG). In practice, NB is selling NOK in the market, primarily against USD and EUR.

The lower announced FX purchases are probably related to the recent drop in energy prices. However, the reduction in purchases for December was both unexpected and very sizeable, and followed another surprise decrease in November. We think there may be an ulterior motive behind the Finance Ministry and Norges Bank’s move: offering some support to the krone.

NOK is the least liquid currency in G10 (left-hand chart below), which means it is extremely sensitive to global risk dynamics and financial conditions. While the deteriorating liquidity and risk environment in 2022 was the primary driver of NOK weakness, Norges Bank’s acceleration in FX purchases in September and October may well have added pressure on the krone.

NOK is the best performing currency in G10 today, trading 1.10% higher against the USD and 0.7% against the euro thanks to Norges Bank’s announcement.

In our view, a stronger domestic currency would be welcome in Norway as it would help fight elevated inflation. The most recent CPI reading surprised to the upside once more, revealing an increase in prices to 7.5% in October, significantly higher than the 5.4% average fourth quarter Norges Bank estimates (published in September). As a result of growing economic downside risks, NB has slowed the rate of tightening, raising it only 25bp to 2.50% on November 3rd. Most importantly, its current rate projections only indicate 60bp of additional tightening, which might prove insufficient to bring inflation sustainably lower.

However – along with general concerns about the slowdown in the economy – hawks at the NB may be discouraged by the vulnerability of the Norwegian housing market. As shown below, Norway has the largest share (nearly 96%) of variable rates in G10, which is unquestionably an element of concern given rapidly rising rates. Too much tightening risks causing an undesirably rapid contraction in house prices.