Norway, Sweden Debate Adopting Euro as Currencies Weaken
Norwegian kroner is now close to record lows against both the US dollar and euro
The poor performance of the Norwegian and Swedish currencies since 2022 has sparked a debate among policymakers, economists, and the general public in both countries about their currencies' future, with some suggesting it is time to consider adopting the Euro.
The Norwegian kroner (NOK) is now close to record lows against both the US dollar and euro, barring dramatic falls during the coronavirus pandemic's early days. The NOK and Swedish krona (SEK) have performed poorly this year, with the former losing 3.17% against the euro and the latter 3.21% year to date.
Weaker currencies have made it more expensive for Norwegian and Swedish manufacturers to import the machinery, transport equipment, and vehicles that drive their industrial sector. It is also hurting consumers in Norway, with inflation at 2.80% in July well–above the government’s target of 2%.
This has led to calls for a re-evaluation of current monetary policies. Norway's Sveinung Rotevatn, a former environment minister and opposition Liberal Party lawmaker, has suggested pegging the krone to the euro, a radical proposal that reflects the severity of the situation.
"The weakness of the krone makes everything more expensive, since we import practically all consumer goods," Rotevatn said in the Financial Times. “This leads to inflation, which again leads to high interest rates. The loser is the Norwegian consumer.”
Norway’s Fundamentals
Given Norway's strong economic fundamentals, including low unemployment and substantial wealth from its oil reserves, some have questioned the reasons for its decline. Kjetil Olsen, chief economist for bank Nordea, said the devaluation is “viewed as a mystery, and there isn’t one story on this.”
Partly in response to the currency’s valuation, the country’s central bank, Norges Bank, decided to keep its policy rate unchanged at 4.5% at its meeting on August 14. The central bank said that it “was particularly concerned with developments in the krone exchange rate and the potential implications for inflation.”
Economic indicators such as GDP growth, manufacturing PMI, and house prices have also influenced Norges Bank's policy decisions. GDP growth is on track to hit the 0.8% central bank forecast for 2024, and manufacturing PMIs rebounded to the highest point since April 2022. Mortgage demand also rose in 2024, indicating that the market might be resilient for a “higher for longer rate approach” if necessary.
With Norges Bank's rate unchanged and the Federal Reserve’s benchmark between 5.25% and 5.5%, the interest rate differential has made the krone less attractive to investors. Norway’s publicly listed market is relatively small (less than $400b) – giving foreign investors little maneuvering space and opportunities to buy NOK-denominated assets.
“Based on our current assessment of the outlook, the policy rate will likely be kept at the current level for some time ahead,” Norges Bank's Governor Ida Wolden Bache said on August 14.
A lack of liquidity makes the krone highly volatile, especially during periods of market uncertainty. This volatility is exacerbated by Norway's heavy reliance on oil – an asset more volatile than most others.
SEK Challenges
In Sweden, the poor performance of the krona has sparked a political debate about the future of the currency. Since 2020, it has declined around 10% against the euro and struggled to recover after experiencing a housing market bubble burst in 2022.
The Moderate Party, currently the governing party that won the most seats in the European Union parliamentary elections in June, are open to revisiting the issue.
It has been “a long time since we looked into the issue,” Karin Enström, the party secretary, said, referring to the referendum from 2003 that saw a 55.9% vote against eurozone membership. “Maybe it's time to start doing so," he said.
However, the right-wing Swedish Democrats remain opposed to the idea. "We've had one referendum, and there was a clear 'no'. There's not yet any support in parliament for a new referendum," Mattias Bäckström Johansson, the party's secretary, said.
Support for switching to the euro among the population has risen to 34.4%, up from 30.6% last year, according to a recent survey by Statistics Sweden.
Reasons for Weakness
Swedish Central Bank's (Riksbank) staff memo from 2021 highlights three potential reasons for Krona's persistent weakness.
First, reforming Sweden's pension system led to increased investments abroad, reducing demand for the domestic currency. Second, the Riksbank's purchase of government bonds decreased foreign holdings, weakening demand for SEK.
Finally, Sweden's historically low interest rates compared to other currencies like the USD, GBP, and EUR may have contributed to the krona's decline over the past decade.
Riksbank sold around 500 million SEK daily to boost its foreign reserves in 2022 when the krona declined 8.2% against the Euro and 15.1% against the US dollar.
Denmark’s Peg
Denmark may be the country that Norway and Sweden ultimately end up following.
The country has successfully maintained the Danish krone peg to the Euro since its introduction in 1999, after previously tying it up to the Deutsche mark.
One key factor contributing to Denmark's success is the National Bank's substantial foreign exchange reserves, which provide a significant buffer against market volatility. With reserves exceeding €65 billion and an additional €24 billion swap line with the European Central Bank (ECB), Denmark is well-equipped to intervene in the currency market when necessary.
Yet large reserves and liquidity access are only a part of the success.
Denmark is a very stable economy that runs a consistent current account surplus. The government has kept budget deficits low, even during crises like the COVID-19 pandemic, and has maintained a relatively low debt-to-GDP ratio.
Though not immune to crises, the country's banking sector has generally been well-managed, reducing the likelihood of financial instability that could undermine the currency peg. Danske Bank (CPH: DANSKE) has risen 200% since it bottomed in early 2020.