9 January 2014 FX Blueprint: Thin end of the wedge • Norges bank to continue to balance falling house prices vs. sticky CPI. • NOK cheap, but investors wary of jumping back in unless/until Norges Bank and/or crude provide support supportive. In Norway, the mainland economy has been growing around 2.0-2.5% YoY for most of the last couple of years, with the recent PMI and manufacturing output suggestive of continuing improvement going forward. Norges Bank's focus is balancing the declining housing market against sticky inflation at the consumer level. With house prices having slowed to largely flat on the year, representing a 3-3.5% drop from the peak in Q3 last year, and headline CPI back in line with the Bank's 2.5% target (from 3.2% YoY in August), Norges Bank is erring on the dovish side, arguing that the rise in (core] inflation is transitory. Indeed, according to the Bank's projections, core inflation is expected to drift back up over the next few months, reaching a peak just above the inflation target of 2.6% in April/May, before dropping down and remaining just below 2% up until the end of 2015. House prices meanwhile, are seen slowing further, to -2.5% to -3.O% YoY in HI 2014, before returning to positive YoY growth in early 2015. The risk to Norges Banks's finely balanced outlook for inflation and housing is twofold. First is a scenario in which past and current FX weakness feeds through to imported inflation, thus preventing core from moderating in line with Norges forecasts. If the Bank then feels compelled to hike rates at a time when house prices already are declining, that would exacerbate the decline and not be currency supportive. An alternative risk scenario is if the house price falls feeds on themselves. With policy rates already as low as 1.50%, and with core CPI projected at or above target over the next 3.6 months, there would be limited scope for policy to provide a stopgap. While the above scenario