Norges Bank Fears Turmoil

illustration: graph

(11.08.2011) Norges Bank chose yesterday to keep key policy rates unchanged. Market interest rates fell but the decline was also affected by decline in other European rates.

By Kyrre Aamdal, Senior Economist at DNB Markets

Fed's signals of expansionary monetary policy for a long time helped markets, but the effects were short-lived. Yesterday fears of the European debt crisis and contagion effects returned and lowered stock and bond prices. Much attention was given to French banks and the exposure to more peripheral European economies.
There were also rumours of an impending downgrading of the French government ratings circulation in the markets, but the three large rating institutions turned out and denied such a move. This illustrated the very nervousness in the markets.  French bank's stock prices did fall markedly, with Societe Generale down 14.7 per cent.

In the US markets bank stock prices generally declined over 8 per cent. Several other sectors were also down, and the S&P500 index fell 4.4 per cent. Investors turned to Treasuries, and the 10-year Treasury yield fell to 2.08 per cent when the US markets closed. During the Asian session the Treasury yields have increased somewhat.

Major Asian stock indices fell further today, but European markets have opened positively. From yesterday morning the Euro has fallen 0.9 per cent versus the USD and 0.4 per cent versus the Swiss Franc. The Norwegian Krone is down 0.4 per cent versus the Euro and thus 0.8 per cent versus the CHF.

The Swiss National Bank (SNB) said in a statement yesterday that "...The substantial rise in risk aversion on the international financial markets has further intensified the overvaluation of the Swiss franc in the last few days. In the light of these developments, the Swiss National Bank (SNB) is taking additional measures against the strength of the Swiss franc. It will again significantly increase the supply of liquidity to the Swiss franc money market. The SNB aims to rapidly expand banks’ sight deposits at the SNB from currently CHF 80 billion to CHF 120 billion. To accelerate the increase in Swiss franc liquidity, the SNB will additionally conduct foreign exchange swap transactions. The foreign exchange swap is a monetary policy instrument which the SNB uses to create Swiss franc liquidity. It was last employed in autumn 2008. The massive overvaluation of the Swiss franc poses a threat to the development of the economy in Switzerland and has further increased the downside risks to price stability. The SNB is keeping a close watch on developments on the foreign exchange market and on financial markets. If necessary, it will take further measures against the strength of the Swiss franc". The latter is probably a signal of market interventions.
Norges Bank decided to keep the key monetary policy rate unchanged at 2.25 per cent at today’s rate meeting. There was great uncertainty associated with today’s rate decision, in light of the recent financial turmoil, and increased uncertainty regarding the global economic outlook. The reference monetary policy strategy from June implied a rate hike at this meeting. Yet, the central bank decided to keep the key policy rate on hold, and instead refer to the alternative central, which they insist not should be interpreted as "the new rate path". Any how, the alternative path suggests only one more rate increase this year, and around four hikes in 2012. Compared to the reference path from June, the downside path is roughly 50 basis points lower at the end of 2012.

In its statement Norges Bank said: " Developments in the Norwegian economy have been broadly in line with that projected in June. This suggests that the key policy rate should be raised further. On the other hand, inflation is low. The turbulence in financial markets has intensified recently and there are clear signs of weaker growth internationally. This also affects the outlook for the Norwegian economy. An overall assessment of the outlook and the balance of risks suggest that the key policy rate be left unchanged at this meeting". Towards the end of the meeting Norges Bank received fresh inflation figures showing that inflation had picked up close the bank's forecast. But the Executive Board did not seem to have put much weight on that information. The FRAs fell 10-15 bps yesterday, but half of the decline was related to declining European rates.