The Mystery of the Norwegian Krone

Ultimately, the strength of a currency depends on the strength of its underlying economy. Norway, as a major energy producer, has a strong economy and therefore a strong currency. Recently, the Norwegian currency has weakened remarkably, especially against the euro, to its lowest level in three years. Now there are many factors that influence the development of currencies and often it is only in retrospect that it is clear which factor was the deciding factor. As an energy producer, the Norwegian currency is somewhat more strongly linked to the dollar and thus to oil price developments, but this is not enough to explain the fall this year. However, a significant portion of the energy revenue is invested through the Norwegian Oil Fund, which after all amounts to swapping the Norwegian kroner for another currency. Sometimes it is as simple as following the flow of money. Of course, the Norwegian Oil Fund is a significant factor, both in the Norwegian economy and the Norwegian krone. Last year there were weeks when the fund became 10,000 euros richer per Norwegian per Week. At the same time, the Norwegian Oil Fund suffered solid losses in the financial markets in 2022. Thus, in addition to its sensitivity to oil price developments, the Norwegian krone is also sensitive to financial market developments.

It is possible that interest rate differentials are also contributing to the decline in the Norwegian krone versus the euro. The ECB seems to be more determined in raising interest rates than the Norges Bank. Just last month, the Norges Bank raised the policy rate by 0.25 percent to 3.0 percent and the expectation is that the policy rate will eventually stay at 3.5 percent. The ECB appears to be moving higher. Given the development of the inflation in Norway, that may not be enough. Inflation rose more than expected last month by 6.5 percent, due in part to rising electricity prices. This while Norway initially had inflation well under control.

The Norwegian krone is the worst performing currency in the G10 this year. The Norwegian economy is shrinking due to developments in construction and energy-related activities. That weak krone may cause more inflation, a reason for Norges Bank to support the currency. Trade-weighted, the Norwegian krone now looks undervalued. Perhaps the weakness of the Norwegian krone can be explained by the currency's limited liquidity. This makes it highly sensitive to the development of financial conditions and these are very tight these days. It is possible that a turn by the Fed and at least the ECB will help get the Norwegian Krone back below 11 Kroner versus the euro. Meanwhile, Norway as a vacation country has thus become about 15 percent cheaper for the rest of Europe in a short period of time.

The weak Norwegian krone may also create an attractive entry point for the Nordic bond market. This is a relatively small market (thus also not as liquid and that gets extra punished in times like these) compared to the U.S. or European bond markets. The effective yield on these bonds is higher than in Western Europe and the United States while that higher yield is not explainable based on the underlying fundamentals. Currently, the initial yield is around 8 percent, a return comparable to that of stocks over the long term. A relatively large proportion of the bonds in this market have floating rates. Furthermore, Nordic markets are well protected against rising energy prices next winter. About half of all Nordic bonds are unrated, even though the underlying companies would usually be classified as investment grade. On top of this solid initial yield then comes the recovery potential of the Norwegian krone. On average, the market is now counting on a 6.5 percent recovery over 12 months.