BNY’s Geoff Yu notes that stronger Oil prices have improved Norway’s terms of trade, but EUR/NOK gains have pushed up the I-44 import price index. While Norges Bank can focus on domestic factors thanks to NOK’s year-to-date performance, Yu warns that high investor holdings and a weaker valuation case make short EUR/NOK trades unattractive, with risks tied to wages and inflation expectations.

Import pass-through and positioning weigh on NOK

“The surge in oil prices this year generated a significant terms-of-trade improvement for Norway. The gains are not as strong as the 2022 surge, which means there isn’t a tailwind from central bank sales to generate further NOK weakness. Like other EUR crosses, EUR/NOK also strengthened materially during Q2, which significantly pushed up the I-44 import price index.”

“There are already signs that Norwegian import prices are following Sweden’s path, where the basket is diverging more from EUR/NOK itself, raising pass-through risk.”

“Despite the risks, the strength of NOK performance year-to-date is a robust buffer against inflation figures, allowing Norges Bank to remain fully focused on domestic factors. The energy-dominant nature of current supply shocks means the currency’s reaction function to external factors differs markedly from peers’. Nonetheless, vigilance is necessary, as higher import prices also risk pushing up inflation expectations and generating second-round effects that Norges Bank must respond to.”

“Risk reward is poor to be short EUR/NOK. Compared to the likes of PLN and SEK, the valuation case for NOK is far weaker. We also highlight that our data point to very high-level holdings of NOK relative to G10 peers, which is a perennial headwind against further performance.”

“Unlike PLN and SEK, NOK will likely respond far more strongly to domestic triggers, especially wages. Transmission from import costs to labor takes longer, but history shows Norges Bank will react proactively to any such risks.”