12/4/2015 6:21:12 PM
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GKFX – Things are Warmer in Sweden but it’s still chilly in Norway- 021215

Warmer in Sweden; still chilly in Norway

The policy shackles should finally start to loosen for the Swdish Krona (SEK) next year when growth will eliminate the output gap and core inflation should see 2%.

So says JP Morgan in a recent one year forcast report. They comment that the Riksbank’s hyper-sensitivity to the exchange rate is not sustainable for a local economy that is cyclically stronger and structurally sounder than the Euro area. There are limits to the Riksbank's policy of shadowing the ECB given macro divergence.

EUR/SEK should eventually test the bottom of this year's 9.10-9.70 range in 2H on a late-cycle de-coupling of ECB and Riksbank policy.

NOK is more challenging to forecast as its performance this year was dominated by a risk premium. Neither oil nor rates explained the rally in EUR/NOK which have left it 4% overvalued.

But the Cyclical risks to NOK are limited from here on as fiscal policy relieves some of the pressure on monetary policy.

FX weakness serves the Norges Bank’s purpose in facilitating longer-term economic re-balancing. The bank it seems is not worried about the CPI consequences and the worst real rates in G10 are a dead-weight on NOK.

Overall Scandinavian FX has been blighted by assertive monetary policy again this year. Neither above target inflation in Norway nor above trend Swedish growth stayed the hand of the region’s central banks.

They have clearly continued to regard their economic glasses as distinctly half-empty. The Riksbank marginally out did the Norges Bank with 35bp of rate cuts and 5% of GDP in QE. This compared with 50bp from the Norges Bank.

And yet the NOK was the harder hit. It fell another 13% versus USD this year. It also fell by another 3% versus SEK and 1.5% versus EUR. And in addition  has now lost 36% of its value versus the USD since 2013. Whereas SEK has shed 25%.

Norwegian policy has been focused on supporting the economy from the double-dip in the oil price and the looming overall structural demise of the energy sector.

Whilst In Sweden the Riksbank prioritised a rapid rise in inflation partly to anchor the 2016 wage round. The exchange rate consequently assumed much greater importance for the Riksbank. Policy was calibrated to the ECB instead of the fast-growing economy which showed the strongest growth in G10.

The NOK is the more economically challenged of the two currencies. Sweden's lack of inflation is in part cyclical and could start to take care of itself as the output gap is soon to be eliminated.

Norway's growth problem is not only cyclical thanks to low oil prices. But it is also structural. The high wage legacy of the oil boom complicates the longer-term task of rebalancing the economy away from its dependency on the energy sector.

This implies that Norway’s weak FX policy should outlast Sweden's, with implications for a deeper setback in NOK/SEK next year unless oil can rebound much above $60.

Meanwhile NOK depreciation is a work-in-progress. The uncertainty about Norway’s longer term growth potential and policy prospects warrants a risk premium in the currency.

The size and variability of the resultant risk premium introduces material uncertainty into the NOK forecasts. The EUR/NOK is 4% overvalued at present. SEK has been and should remain a better-behaved currency than NOK.

JP Morgan’s view  is constructive on SEK based upon cheap long-term valuation and robust economics. Sweden boasts a current account surplus near 7% of GDP and It has the fastest real and nominal GDP growth in G10. Real growth is a little above 3% this year and is expected to be only a little shy of the same number for next year.

Nor is Sweden’s outperformance a new phenomenon – cumulative GDP growth since 2005 is 4-5% more than in the UK or the US.

These fundamentals would then  appear to warrant a Swedish krona appreciation of perhaps as much as 5-10%. What prevents us being so bold – we project a 3% gain versus EUR - is the Riksbank. Who continues to target a weak exchange rate in order to fast-track inflation.

JP Morgan’s forecast envisages a gradual decline in EUR/SEK next year to the bottom of this year’s range around 9.00-9.10.

The outlook for the Norges Bank and NOK rests then entirely on the country’s prospects for growth. This is not simply related to the depth of the downturn. The economy there is stabilizing having flirted with contraction. But also the longer-term growth potential for an economy that has leveraged the oil price boom, but which now needs to adjust and rebalance to permanently lower crude prices. Also compounding this will be the slow decline in production volumes. This task is also compounded by a major loss of wage competitiveness.

Norway has not proved immune to the Dutch disease and excess energy sector wages have spilled over into the mainland economy. Norwegian unit wage costs have increased by nearly 40% against the OECD average since 2002.

The NOK’s 4% risk premium then could relate to uncertainty about just how rebalancing in the economy will proceed. And this is where we will leave that  pint .

Crude prices would need to rebound by a further one-quarter to one-half to assuage these structural concerns. This is particularly so regarding the viability of offshore capex. Breakeven rates on new projects can be in the $60-70/bbl range. As it is, the Norges Bank expects offshore capex to fall from 8.7% of mainland GDP in 2013 to only 5.7% by 2018.

The global slump in oil capex also impacts Norway through mainland exports one quarter of which are petroleum-related. Capex is expected to fall another 5% in 2016 on top of this year’s 22% crash.

FX investors may also be concerned at the extent to which the Norges Bank is seeking to promote this rebalancing through a cheap currency.

This suspicion has been fuelled by the Norges Bank's total indifference to the inflation pass-through from multi-year NOK depreciation. Core inflation is currently above 3% and the Norges Bank expects it to remain above target for the whole of 2016. The central bank also predicts three more years of easy money with the first hike not coming until 2H18.

If the central bank’s goal is to restore competitiveness then there is quite a bit more FX depreciation in store for the NOK.

Well that’s it for this look at the Scandis  

This has been Alex Heath for GKFX 

Godbye and thanks for watching .