Even with an expansive sovereign wealth fund designed to buoy the Norwegian economy during periods of lackluster economic activity, the enduring weakness in energy prices continues to claim casualties. This time around, the latest collateral damage from the oil patch was unemployment which rose to the highest levels since record keeping began. The oil economy has touched every corner of domestic activity in Norway, from the government budget to consumer spending. While the sovereign wealth fund has been helpful in plugging certain gaps that have arisen from lower energy revenues, they have not been the silver bullet for fixing all of the nation’s problems. Furthermore, despite highly accommodative monetary policy which saw rates dropped to a record low 0.50%, new problems are emerging, which may contribute to a sustained period of weakness in both the economy and Krone.

The Economic Casualties

As the rout in oil and gas prices continues unabated for a second straight year, the ripple effects of this development are being felt throughout the Norwegian economy. For the first half the year, the government budget, which is heavily dependent on the energy industry, saw revenues from the sector that were -29.00% lower than the same period a year earlier. Although extraction costs are in the middle of the range, numbering close to $21.31 per barrel, meaning the industry is profitable at current levels, it is not enough to plug the growing hole in the government budget. As a result, the government has been forced to tap into the nation’s sovereign wealth fund, which thankfully was designed for this specific purpose. However, despite the flexibility afforded by the wealth fund, other areas of economic activity are unable to draw upon those benefits.

In an effort to hedge against the downside from weak oil and gas prices, the Norges Bank brought the key rate down to 0.50% in March to help spur growth in other areas of the economy during a particularly challenging time. So far the impact of this policy measure has been minimal in terms of growth, evidenced by GDP flat-lining at 0.00% during second quarter. While beneficial considering it prevented an outright GDP contraction, additional accommodation may not be possible, namely due to inflation. Although it has tapered considerably from the blistering 4.40% reported back in July, August’s headline CPI figures continue to underscore the challenges facing the Central Bank.Loosening policy could be the key to fighting unemployment which has risen to a 19-year high of 5.00%, however, high inflation and high unemployment combined with low growth is the recipe for stagflation.

The inter-connectedness of the Norwegian economy and the energy industry has meant that the Krone has also been heavily impacted by the hefty decline in prices. A weaker Krone is a key contributor to higher inflation, with further accommodation likely to translate to additional losses in the Krone. Thankfully, signaling from the US Federal Reserve on its own rates may reduce pressure on the Norges Bank to act. Nevertheless, further weakening of the Krone may keep inflation elevated well above the Central Bank’s 2.50% target, tying up future policy initiatives until it comes back towards the long-term goal.With little room for policy errors, the Norges Bank will probably be forced to hold fast over the medium-term until inflation retreats before easing policy further, which may help bolster the Krone value.

Technically Speaking

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Although the economy may be underperforming due to the ripple effect of weak energy prices, the Krone has actually shown some gradual improvements, with the USDNOK pair in a modest medium-term downtrend since the outset of 2016. While part of this may be attributed a weaker US dollar, the pair is trending below both the 50 and 200-day moving averages each of which is acting as resistance and contributing to the downward pressure as evidenced by the pair’s recent bounce off the 50-day moving average. Furthermore, on a longer-term basis, the bearish head and shoulder’s setup that has emerged also has a bias to the downside. Any candlestick close below the neckline at 8.0358 could spur a move towards 7.6000, marking a downward breakout in the pair. However, should the shoulder line at 8.6167 to the upside, the pattern would be deemed broken, with the potential for USDNOK to make a run towards 8.9836.

Looking Ahead

The most important development that will sway the outlook for the Norwegian economy in the immediate future is the FOMC decision. Should the US Federal Reserve opt against raising rates sooner than later, the dollar may come under renewed pressure, pushing USDNOK downwards. Such a move would help temper inflation and give the Norges Bank more room to act on rates to fight unemployment and low growth. However, aside from the US Central Bank decision, the upcoming energy conference being held in Algeria could give oil prices the lift they need to help the Norwegian government recover from recent revenue losses, enabling more fiscal stimulus. However disappointment in either of these categories could spur further Krone weakening, a development that may have widespread negative implications going forward. A weaker Krone will reduce the tools available to patch the Norwegian economy for long-term outperformance.