Norges Bank will hike today

Renewed uncertainty around the situation in Greece sent the euro downwards yesterday. Today, Norges

(12.05.2011) Renewed uncertainty around the situation in Greece sent the euro downwards yesterday. Today, Norges Bank will (eventually) hike the signal rate.

By Knut A. Magnussen, Senior Economist at DNB Markets

Markets were rather negative yesterday, with stock markets falling in the US (S&P down 1.1%), in Europe and in Asia (Nikkei down 0.8%). A strong auction and flight to safety sent long US yields lower, while weak stock data lead to a decline for the crude oil price. Renewed fear of Greek debt restructuring weakened the euro significantly yesterday and EURUSD was traded as low as 1.4170 in the evening. In our new forecasts we expect that the EURUSD will fall gradually toward 1.30 in the coming year.

The main event in Norway today is the rate meeting. Norges Bank is widely expected to hike the sight deposit rate by 0.25 bps. This is also to a large extent prices in, so such an outcome should not affect market rates or the NOK much.

In the monetary report in March the central bank showed that there was a 50% probability of a hike in May and the same for June. We think that events since then have favoured a May hike. Of most importance is that the ECB hiked in April, the labour market has improved markedly and wage growth has picked up more than anticipated by the central bank.

In our new forecasts, released yesterday, we have adjusted the future rate hikes upwards. We now expect the next hikes in September and December this year, then four hikes in 2012 and another three in 2013. We expect that the ECB will hike twice more this year, but then keep the refi rate unchanged during 2012. Hence the rate spread between Norwegian and European signal rates will increase. This is likely to imply a stronger NOK, but this will be necessary in order to keep inflation close to the target in the medium term.

Bank of England released a new inflation report yesterday. As we expect the report indicated that the first rate hike will be delayed compared to the previous report. The fan chart shows that inflation will slow towards the target in the medium term, given market rates and that the level of central bank reserves remain at 200 bill. GBP.

However the report underlines the large uncertainty with respect to the timing and the extent by which inflation is likely to decline. In the short term inflation is expected to pick up more than in the previous report, and to reach 5%. As the market is pricing in the first hike toward the end of the year, the report implies a substantial delay of the first hike. Furthermore, the market expects that the bank rate will be hiked by 1%-point in 2012 and by the same amount in 2013 and reach almost 3% at the end of 2014. I our new forecast we have delayed the first rate hike to the spring of 2012.

The US trade balance weakened more than expected in March. The balance fell from 45.8 bill. USD to 48.2 bill. USD. Exports rose a healthy 4.6% from February, but this was counteracted by an even stronger increase in imports (of almost 5%) thanks to higher crude oil prices. Today US retail sales for April is due. It is expected that sales will increase by 0.5% - almost the same as in March. However, higher gasoline prices are lifting (nominal) sales. Gas prices rose around 10% from March to April.

Central bank governor Bernanke will speak to the Senate this afternoon, but will hardly give any new signals. In our new forecasts we have pencilled in the first rate hike from the Fed in the spring 2012. The forecast is dependent on a continued improvement of the labour market in the coming year. Initial claims are expected to fall substantially from 474.000 to 430.000 this afternoon.

According to the FT Angela Merkel has now given her support to Mario Draghi as new central bank governor in ECB, following the support from Sarkoxy last week. Hence it seems clear that Draghi will replace Trichet in October.