Inflation gives mixed signals

(11.03.2011) Rising inflation in the UK contributes to interest rate hikes approaching. In Norway and Sweden, however, the inflation development was on the downside for a second consecutive month. In isolation, this implies for less haste in hiking policy rates.

By Maren Romstad, Analyst at DNB Markets

illustration money, coinsIn currency markets yesterday both the Norwegian krone and the Swedish krone wakened.

Most of the depreciation of the Norwegian krone occurred around the publication of inflation figures, which were weaker than expected by both consensus and Norges Bank. The annual growth in core inflation was 0.8 per cent in February, while the central bank had estimated growth around 1.0 per cent.

For a second consecutive month inflation figures surprised on the downside of Norges Bank’s inflation forecasts, and thus imply a lower inflation rate path in the short term when this year’s first monetary policy report is presented next week. Yesterday’s figures also indicate that Norges Bank will be in no hurry to hike policy rates and we don’t expect the next rate increase before June. Yet there are still several other factors that imply higher interest rates, such as higher growth and interest rates abroad, signs of higher wage growth and a smaller premium on three month rates than previously expected. Hence, we expect the new interest rate path to be somewhat higher than today, indicating the next increase with a 50 per cent probability in May or June.

Currently market’s expectations are more aggressive than our forecasts, and may imply a weaker Norwegian krone going forward. Our view on interest rates relative to the market is one of the reasons why we expect a weaker NOK against the euro in the next month.

The same picture also applies for the Swedish krona, which also weakened after the publication of inflation figures yesterday. The annual growth rate was 1.3 per cent, far lower than the Riksbank’s expectations at 1.7 per cent. So as in Norway, actual inflationary pressure is lower than estimated and, thus, may restrain how much the Riksbank can hike the repo rate in the future.

There are of course several risk factors for our view. Both Norges Bank and the Riksbank may emphasize strong growth in housing prices more than expected, and at the same time signals of other countries soon hiking policy rates could give both central banks more room in terms of strong currencies.

A trading partner that has indicated interest rate increase is the United Kingdom, but as expected they kept their monetary policy rate unchanged at yesterday's meeting. Yet there are several factors suggesting that they are in the process of establishing a majority in the committee to hike rates, especially concerns regarding rising inflation.

Given yesterday’s market reaction, however, it appears that some had expected a hike already at yesterday's meeting, as pound sterling weakened after the decision was announced. We expect the signals from the central bank to become clearer in the direction of an imminent interest rate increase, which suggests that the pound may appreciate. The first hike is expected in May, which currently is earlier than consensus. According to Reuters the majority of 63 analysts expect the first interest rate increase from Bank of England in the third quarter.


China is one of the few countries that have already begun to tighten policy to fight rising inflation. In February, inflation remained unchanged, but is still at high 4.9 per cent. This was higher than expected and also higher than the recently adopted inflation target for 2011 at 4 per cent on average. Hence, it seems possible that the Chinese tightening continues. The markets in general were once again affected by high oil prices, turmoil in Libya, a huge Japanese earth quake and worries regarding European government debt. In addition to news of Moody's downgrading Spanish government debt, we also got several weak US macro figures. The weekly employment figures disappointed, while the trade deficit was reported to be the largest in five months. In currency markets, the dollar has strengthened against the euro. The common European currency is likely weighed by member countries state finances once again, and has also weakened against the Swiss franc.