Norway Surprises and Ongoing Funding Woes

Norges Bank cut its official deposit rate by 50 bp to 1.75%. Most were looking for a 25 bp move, but some local banks had been warning of a 50 bp. The central bank was clearly concerned about the knock-on effects from the euro zone, but also noted that market funding for Norwegian banks was less accessible.

The dollar funding pressure continues to be seen. Many observers thought last week's 3-month dollar auction that saw a bit more than $50 bln placed eased the demand. We argued to the contrary, the dollar demand is much greater and we expressed mild disappointment.

The cost of swapping from euros to dollars has increased by 38 bp since last week's dollar auction to now stand near 147 bp below 3-month Euribor. The 1-year swap rate is also edging higher. The ECB's 7-day dollar auction saw a little more than $5 bln taken, but we suspect there will continue to be funding pressure, which is unlikely to be alleviated by the year-end roll.

Spain reported today that Spanish bank borrowing from the ECB rose to 98 bln euros in Nov from 76 bln in Oct. Tomorrow France will report its figures, In October, French banks borrowed 158.5 bln euros from the ECB, up from 147 bln in September and a little less than 70 bln in August. French banks as a whole appear to have replaced a good part of the funding that was previously provided by US money markets with borrowing from the ECB.

Today is the first day of the new reserve maintenance period at the ECB. Overnight deposits at the ECB had swell to the year's high of 346.4 bln euros on Monday.

The ECB offered a quick tender to drain the excess reserves, as is typically of the end of a maintenance period. Unappreciated by many observers, as part of the liquidity provisions announced last week, the ECB indicated that starting this month it will no longer arrange the mopping up exercise. Overnight deposits at the ECB will begin building again as banks seem to front load their reserve requirements.

By cutting 50 bp in one swoop, the Norges Bank hopes to get ahead of the curve. This is part insurance against addition headwinds, but also responds to the recent data indicating an economic slowdown. The non-oil, gas and shipping economy expanded 0.8% in Q3 from 1.3% Q2. Last week, the Stats office cut its forecast for 2012 growth to 2.5% from 3.5%.

The euro jumped against the Norwegian krone from 7.74 to about 7.78. The krone has been the weakest G10 currency against the dollar thus far this week, losing 2.3%. The Swedish krona is the second weakest losing about 1.7% against the dollar. The Riksbank meets next week (Dec 20). Norway's larger than expected rate cut will likely fan already existing speculation of a 25 bp rate cut. The dollar is approaching the high for the year against the krona, which was set in late Nov near SEK7.02.