Norway is one of the few countries that have tightened monetary policy post-crisis. However, that tightening cycle appears to have ended and the Norges Bank is likely to keep rates steady when it meets this Thursday. Meanwhile, political uncertainty is increasing with the recent collapse of the government.
Political uncertainty is rising. Right-wing coalition partner Progress Party has pulled out of the government over a decision to allow an alleged ISIS bride back into the country. The other three parties in the coalition (Conservative, Liberal, and Christian Democrats) had allowed a Norwegian woman accused of aiding ISIS in Syria to return to Norway for urgent medical for one of her children. Progress Party leader Siv Jensen also stepped down from her post as Finance Minister.
Prime Minister Erna Solberg of the Conservative Party said she plans to continue ruling as a minority government. Her deputy leader Jan Tore Sanner is said to be a leading contender for the post of Finance Minister. Solberg said she hopes to complete a cabinet shuffle by the end of this month. The Progress Party held six other cabinet posts besides Finance, and so due to the intense work needed, Solberg cancelled her planned trip to Davos. Fresh elections are not due until September 2021 and the constitution does not provide for early dissolution. Together, the three remaining coalition partners now hold only 61 seats in the 169-seat parliament after losing Progress Party’s 27 seats.
Norges Bank meets Thursday and is widely expected to keep rates steady at 1.5%. We expect a dovish hold, as the bank has been very clear that downside risks remain in play. The current rate path suggesting steady rates through 2023 is likely to be maintained.
A BRIEF HISTORY LESSON
Norway came relatively late to the oil producing game. As recently as the late 1950s, few believed that the nation held significant oil reserves. However, the discovery of the Groningen gas field by the Netherlands in 1959 raised the possibility of finding hydrocarbons under the North Sea. In 1962, Philips Petroleum applied for exclusive rights to conduct exploration in the parts of the North Sea that were in Norwegian waters or part of the Norwegian continental shelf. Norway was hesitant to grant such rights, believing instead that many companies would be needed to develop this massive project.
In 1963, Norway established that any natural resources in the Norwegian continental shelf belonged to the state. By 1965, acceptable boundaries had been established with the UK and Denmark and so Norway began the first rounds of bidding for exploration rights. Development was slow at first. The first well was drill in 1966 but was dry. The first discovery came in 1967 at Balder, but that field was not considered financially viable. It wasn’t until 1969 that Norway finally realized the full extent of its oil wealth. The discovery of the Ekofisk field was at the time the largest ever found at sea, with production starting in 1971. More major discoveries were made over the next few years and Norway has never looked back.
The subsequent influx of oil money led Norway to create a Sovereign Wealth Fund. This fund is meant to help insulate the economy from swings in the price of oil as well as to save for the future when the oil runs out. The Government Petroleum Fund was created in 1990 by Parliament and the first funds were deposited in 1996. All assets were to be invested abroad. Originally funded by the revenue from hydrocarbon sales, this now accounts for less than half the total as more than half is now made up of the fund’s investment earnings.
The Fund was initially invested 100% in government bonds but in 1998, 40% was moved into equities. In 2000, five Emerging Market countries were added to the Fund’s benchmark equity index. In 2002, corporate and securitized bonds were added to the Fund’s benchmark fixed income index. Ethical guidelines for the Fund were established in 2004, placing Norway well ahead of the curve.
The name was changed to the Government Pension Fund Global in 2006. The equity share was increased from 40% to 60% in 2007. It also decided to add small-cap companies to the benchmark equity index that year. In 2008, real estate was added to the Fund’s investment universe but only up to a maximum of 5% of the total (later increased to 7% in 2017). Furthermore, all Emerging Markets are added to the benchmark index in 2008. In 2012, the Fund announced plans to reduce the share of European holdings to about 40% of the total and to increase the share of Emerging Markets to 10%. That year, the total value of the Fund topped $1 trln for the first time ever. In 2019, the total value hit another milestone of NOK10 trln ($1.1 trln)
The economy is picking up modestly. Norway’s GDP is typically broken down into the oil and non-oil (mainland) sectors. The IMF sees mainland growth picking up to 2.4% in 2020 before easing to 1.6% in 2021 vs. 1.9% in 2019. Mainland GDP rose 2.9% y/y in Q3, the fastest since Q4 2017. However, monthly data so far in Q4 suggest some deceleration. As such, we see some downside risks to these growth forecasts. At the last meeting December 18, Norges Bank noted that mainland growth has been slowing a bit more than expected and that the economy may be near a cyclical peak.
Price pressures are still slowing. Headline inflation slowed to 1.4% y/y in December, the lowest since November 2017 and further below the 2% target. Underlying inflation slowed to 1.8% y/y in December, the slowest since October 2018. Unemployment at 2.2% remains near the cycle low of 2.1%, yet there has been very little so far in the way of wage pressures.
During the Great Financial Crisis, Norges Bank cut rates from 5.75% in September 2008 to 1.25% in June 2009. It started a modest tightening cycle in October 2009 that took the policy rate to 2.25% in May 2011. The bank then reversed course and started cutting rates in December 2011. A slow but steady easing cycle took the rate down to the 0.5% trough in March 2016.
The current tightening cycle begin with a 25 bp hike to 0.75% in September 2018. Three subsequent hikes over the course of 2019 have left the policy rate at 1.5% currently. After the last 25 bp hike to 1.5% back in September, the bank signaled a pause that has been confirmed in subsequent meetings. The Norges Bank’s rate path continues to show the policy rate likely remaining at the current level until the end of the latest forecast period in 2023. Much will depend on the global backdrop and oil prices but for now, we see steady rates this year.
The fiscal accounts remain solid. The OECD sees the budget surplus rising to 9.1% of GDP in 2020 from 8.8% in 2019. Higher oil prices have allowed the government to use fiscal stimulus without harming the fiscal outlook. The sovereign wealth fund continues to grow, giving policymakers leeway to continue using fiscal stimulus as needed.
The external accounts are improving. The IMF sees the current account surplus widening to 7.2% of GDP this year from 2.8% in 2019. Exports had contracted y/y in USD terms since December 2018 but finally rose y/y this December. The 12-month trade surplus fell over the course of 2019 as import demand remained robust. As such, we see some slight downside risks to the current account forecasts. Lastly, Norway’s Net International Investment Position has risen to a whopping 226% of GDP, the highest on record. As such, its external vulnerability remains extremely low.
Both Brent and WTI oil have given up nearly half of their October-January gains. Both are testing support at their 200-day moving averages of 64.11 and 57.78, respectively. Studies show that amongst the majors, NOK has the second-highest correlation with WTI oil prices at around 0.286. Only CAD is higher at .336.
Nokkie continues to underperform. In 2019, NOK was -1.7% and ahead of only the worst performers EUR (-2.2%) and SEK (-5.5%). So far in 2020, NOK is -2.2% and is ahead of only the worst performers NZD (-2.2%) and AUD (-2.5%).
In early January, EUR/NOK traded at its lowest level since early August. The pair has since moved higher as oil prices have eased, and the near-term direction will likely be driven by oil prices. If oil continues to slide, look for EUR/NOK to test retracement objectives from the December-January drop that come in near 10.0 (50%) and 10.05 (62%). USD/NOK is leading the move and is currently testing its 50% retracement objective from that same move near 8.98. The 62% comes in near 9.03.
Norwegian equities continue to underperform. In 2019, MSCI Norway rose 8.3% compared to 25.8% for MSCI World. So far in 2020, MSCI Norway is up 0.4% vs. 2.4% for MSCI World. With growth likely to improve modestly and oil prices likely to hold on to some of its recent gains, we expect Norwegian equities to stop underperforming so much, as suggested by the NEUTRAL rating for Norway generated by our DM Equity Allocation model.
Norwegian bonds are outperforming. The yield on 10-year local currency government bonds is -13 bp YTD and is behind only best DM performers Australia (-21 bp), Canada (-19 bp), UK (-18 bp), Hong Kong (-15 bp), and the US (-15 bp). With inflation likely to remain low and Norges Bank on hold, Norwegian bonds should continue to outperform. Our own sovereign ratings model shows Norway’s implied rating steady and solidly at AAA/Aaa/AAA.