Chart A goes back to 2008, and although the correlation is far from perfect, it is difficult to dismiss the interest rate differential as a factor behind the NOK exchange rate. We have had two major shifts in the NOK exchange rate and interest rate differential over the past decade.
In 2010-12, the NOK was considered a safe haven. Back then there were concerns the euro would disappear, and Norway could offer high and very profitable oil investments, a relatively strong growth outlook and significantly higher interest rates as an alternative. It was perhaps not so strange the NOK was strong. The euro crisis eventually passed, and in 2014 oil prices took a nosedive. The impression of Norway was turned upside down. Oil investments fell sharply, and profitability in the oil sector was hit hard. Suddenly we were not so special any more, and Norges Bank cut rates while other central banks kept theirs on hold. The safe haven was suddenly the eye of the storm. The NOK weakened significantly and stayed at a significantly weaker level up to the pandemic.
Norges Bank. Highly indebted Norwegian households with floating interest rates may explain part of this difference. Nonetheless, the interest rate differential fell further as a result and at the most extreme point our trading partners had nearly 0.25% point higher interest rates than us. In comparison, there was a positive difference in our favour of around 1.5% points or more in the period before the oil crisis.
Interest rate differentials may affect investors via direct returns on financial positions and thus affect exchange rates. They also reflect the relative relationship between two countries, not entirely unlike exchange rates. Then it is perhaps not so strange there is a correlation.
