(Bloomberg) -- Norway’s battered krone may get a shot in the arm if the nation’s central bank proceeds with an expected change to the way it manages currency reserves.
Analysts and strategists say the currency, which is one of the worst performers this year in the G-10 space of major currencies, may rebound if Norges Bank chooses to start buying it in response to a shift in the government’s liquidity management policy. That may happen early next year after a decision experts anticipate from the central bank around December or January.
The krone is hovering near a 4 1/2-year low, dented by a lower oil price and geopolitical risk aversion. The currency’s weakness — raising risks for imported inflation — has for months been a key factor preventing policymakers from joining most advanced-world peers in monetary easing. The growing interest-rate gap relative to other central banks has so far provided little relief for the krone.
“We could see a shift where Norges Bank becomes a net seller of FX rather than a net buyer,” said Dominic Bunning, FX strategist at Nomura International Plc. “This could mean a much higher potential for the krone’s sizable undervaluation to correct.”
The Japanese bank holds a long position in the krone against the Swedish krona, and Bunning added that the Norges Bank’s buying could set up the krone for a move back above parity in the coming months.
Similarly, Danske Bank A/S sees room for the krone to gain on the shift, and also recommends traders to buy the krone against the Swedish krona, along with the euro.
Still, boost to the currency from these operations could raise the risk that the market will question the central bank’s motives, analysts say, given that it doesn’t want to be seen steering the krone. The central bank has stressed it doesn’t have an exchange rate target and that the threshold for intervening in the FX market is “very high.”
“If Norges Bank sells foreign currency and starts buying kroner it would constitute a big shift in rhetoric from a central bank that has otherwise opposed the idea that FX intervention was a viable solution to counter krone FX weakness,” said Kristoffer Kjaer Lomholt, head of FX research at Danske Bank in Copenhagen.
Last week, Governor Ida Wolden Bache said a change by the government to no longer offset transfers from Norges Bank by issuing debt is prompting the central bank to consider whether to allow its reserves to keep growing, and if so, how this should be funded. One of the options it was looking at was to sell foreign currencies and buy the krone to manage its balance sheet, she said then.
Wolden Bache, specifying the central bank’s stance in emailed comment to Bloomberg, said if officials opt to sell FX reserves as a result of upcoming changes, they “would do so in a manner that ensures a minimal impact on FX markets,” similar to how they conduct FX transactions on behalf of the government.
“How Norges Bank decides to finance the profit paid to the government is not part of monetary policy,” Wolden Bache said. “Our decision will be governed by what we want the bank’s balance sheet to look like in order to have contingency reserves in international currencies while achieving liquidity policy objectives. Once the decision is made, we will communicate this clearly to the market.”
While potential sales could offer some support for the krone, many say the reaction would be minor.
Transfers by Norges Bank to the government in dividends and interest have been in the range of 30 billion kroner to 35 billion kroner ($2.7 billion to $3.2 billion) annually. The central bank conducts monthly currency operations on behalf of the government as part of its so-called petroleum fund mechanism.
According to analysts at DNB Bank ASA, potential selling of FX reserves would mean daily krone sales declining to at most about 200 million kroner “which is too minor to be any game-changer” for the exchange rate.
Dane Cekov, a senior macro & FX strategist with Sparebank 1 Markets AS, said Norges Bank’s net currency transactions will be “around zero” next year, taking into account the expected change, according to a note to clients. He projected the move may “dampen volatility” in the exchange rate.
Should these changes happen, Norges Bank may find itself buying the currency at the same time markets are pricing for it to start delivering interest-rate cuts as inflation subsides.
Traders could also read the move as following in the footsteps of Sweden in finding ways to support its currency while stopping short of outright intervention.
The Riksbank sold $8 billion and €2 billion from September last year to buy the Swedish krona, hedging about a quarter of its FX reserves. While the move was ostensibly an effort to manage risk, economists saw it as covert intervention, and it drove a peer-beating rally for the Swedish currency.
“It will be a communication experts’ nightmare to explain all of these FX transactions Norges Bank could end up doing,” said Sparebanken’s Cekov. “I think this will add to confusion among some FX market participants, overall.”
--With assistance from Niclas Rolander.
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