Pile of Norwegian Krone. Norwegian Currency Financial Background.
11.04.19
Insights

The weakness of the Norwegian krone – Real NOK exchange rate

What impacts the Norwegian krone price to the euro and why is the Norwegian krone so weak? These are frequent questions since some time and it is easy to understand why investors ask these questions. The Norwegian economy is going to once again be the outliar with a likely much stronger GDP growth in 2019 compared to the rest of Europe. Norwegian interest rates are positive, yes you read right, and the central bank recently hiked interest rates and upped their interest rate path.

Norwegian economic activity is booming and the core inflation is above target. The oil price is far higher than the lows and still the Norwegian krone (NOK) is very weak to the (EUR), no wonder investors wonder why.

In this article I’ll highlight one aspect that may put another perspective on the weakness; the real exchange rate evolution where we cancel out the differential in inflation. Is the REAL fall in the NOK less than we think?

The NOK/EUR real exchange rate evolution

What do we mean with real exchange rate? Think of it this way; if we start off with purchasing power parity (PPP) as a regulating factor for the exchange rates and all the same except inflation.  If inflation is higher in Norway than in Euroland it means that the NOK will buy fewer goods in Norway than the EUR will do in Euroland after some time. The PPP demands that this is compensated to respect the equilibrium.  From this we deduct that a currency with higher inflation should depreciate to another currency with lower inflation.

FIGURE 1 – NOK and EUR Inflation

Insight 2019 04 - Real NOK Exhange rate - Image 1

Source: Alfred Berg, Bloomberg, March 2019

As can be seen in figure 1, the EUR inflation has been falling regularly since a decade and a half before stabilising while the NOK inflation has been more volatile and clearly relatively strong in average. The inflation differential has been quite important in the last years.

 

The REAL NOK exchange rate to the EUR

Given the above, we would then expect that the REAL NOK to the EUR has fallen less than the official exchange rate would indicate. But will the effect cancel the NOK’s fall versus the EUR or will it only explain a part of it?

 

FIGURE 2 – The REAL NOK to the EUR exchange rate

Insight 2019 04 - Real NOK Exhange rate - Image 2

Source: Alfred Berg, Bloomberg, March 2019

As can be seen in figure 2, the NOK weakened to the EUR from end 1997 until end 2018 by around 23%. In the same period our calculated REAL NOK to the EUR fell by around 12%.

How should we understand this? The price of a Norwegian consumer basket end 2018 is 10% cheaper in EUR than in NOK compared to end 1997. With other words, the NOK has fallen in inflation adjusted terms 12% to the euro in the period.

Conclusion

The impressive fall in the NOK to the EUR of 23% in the period is in PPP terms only a fall of 12%. What we have shown is that the inflation differential can only explain around half of the depreciation of the NOK in the period, hence there are either other fundamental factors explaining this or this is an opportunity.

Is this an opportunity to buy a too weak NOK?

Given:

  • Norway’s AAA by all three main rating agencies,
  • Norway’s extremely strong state finances,
  • Norway’s pension fund of around 8000bn NOK or close to 850bn€ for a population of 5 million,
  • An expected much higher Norwegian GDP growth than the rest of Europe in 2019 and
  • A recently upped Norwegian central bank expected interest rate path,

I think that there is an opportunity to take on exposure to the NOK at these levels.

 

Dag A.D. Messelt

Head of international business Development

BNP Paribas Asset Management – Alfred Berg

 

Other articles on Nordic currencies:

Potential global trade war – Nordic exports and currencies

Weakening of Nordic currencies due to differing growth prospects?

Why is the Norwegian Krone so weak despite the stronger oil price?

The Norwegian Central Bank has little control of the Norwegian Interbank rates

The Norwegian krone’s correlation to the Brent oil price

 

On the same subject:

Nordic green bonds – is it greener in the Nordics?

The Nordic capital market was early on putting sustainability and ethical investing high on the agenda. Especially large institutional Swedish investors have been driving the demand and other investors have followed. It is maybe not that surprising that the Nordic region played an important role in introducing green bonds in the global capital market.

The Norwegian krone’s correlation to the Brent oil price

«When the oil price tanks eyes turns to the NOKie». We often see the Brent oil price as a factor for explanation of the moves in the Norwegian krone (NOK) versus other currencies, but how does it really work over time? We have been looking closer to this relationship and have some interesting findings. These findings can be split in three levels:

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