The Executive Board's monetary policy decision – background and general assessment
Meeting 15 October 2008
The Executive Board placed emphasis on the following new information that has emerged since the previous monetary policy meeting on 24 September:
- The financial market crisis has intensified further. Money and credit markets have been functioning poorly.
- Owing to liquidity shortages and large losses, several large financial institutions abroad have not been able to continue as independent financial institutions. They have either merged with other financial institutions, been partly or fully acquired by the authorities or are being wound up. The Icelandic authorities have placed the banks Glitnir, Landsbanki and Kaupthing into conservatorship with the Icelandic Financial Services Authority.
- The US and European authorities have implemented a broad range of measures to improve liquidity and the balance sheets of large financial institutions.
- The authorities in the euro area have decided to take joint action as a follow-up to the recommendations of the G-7 nations. Several countries will for a period guarantee issues of new bank debt with maturities of up to five years and make Tier 1 capital available to banks. The UK established a new guarantee scheme for new debt issues by large banks that have either received government capital infusions or have a sound Tier 1 capital ratio. The US authorities are working to strengthen banks’ and financial institutions’ equity capital by allotting USD 700 billion measures to assist the financial sector. The Swedish authorities have established a new fund that will provide support to Swedish banks.
- Bank deposit guarantee schemes have been substantially widened in a number of countries in recent weeks.
- The central banks in the euro area, the US, the UK, Canada, Sweden and Switzerland reduced their key policy rates on 8 October in a coordinated action to address the global financial crisis. Key rates were reduced by 0.5 percentage point by all the banks except the Swiss central bank, which reduced its key policy rate by 0.25 percentage point. China’s central bank also cut its key rate. Australia’s central bank lowered its key rate by 1 percentage point. Market participants expect further interest rate reductions in most of our trading partners.
- Both in the US and Europe, central banks have provided additional liquidity to the banking system and established new facilities to provide liquidity. The Fed has established a facility for direct lending to businesses in light of insufficient access to short-term funding. Lending is provided by purchasing commercial paper issued by companies. The central banks in the US, the euro area, the UK, Switzerland and Japan will conduct US dollar fixed-rate auctions with maturities of 7, 28 and 84 days, with full allotment. A number of central banks, including Norges Bank, have under agreements with the Fed provided funding in US dollars to their markets to address the abnormal situation in money markets.
- Norges Bank has provided large loans (so-called F-loans) to banks against collateral in securities. At the most, overall surplus liquidity in the banking sector has been close to NOK 83 billion. In normal times, the amount is around NOK 20 billion.
- Norges Bank has provided 3-month F-loans, which is a longer term than normal. These loans will mature early next year. Around the turn of the year, many banks have a particularly high need for liquidity. Banks were provided with F-loans in the amount of NOK 30 billion on 1 October. New 3-month F-loans will be provided on 16 October and 1 November.
- Norges Bank will provide F-loans particularly designed for small banks to improve their liquidity. A 6-month F-loan, effective from 20 October, will be provided by auction and a 2-year F-loan will be auctioned in mid-November. In both operations, the maximum bid amount that can be submitted by each bank is NOK 1 billion.
- Norges Bank has eased the collateral requirements for banks’ access to F-loans. Certain types of residential mortgage-backed securities will be accepted as collateral in Norges Bank’s lending operations. The eligibility criteria that such securities must have a credit rating and be listed on the stock exchange have been temporarily suspended. This measure will accelerate banks’ access to increased funding from Norges Bank. The collateral requirements have been eased further by removing the criterion of a minimum volume outstanding of NOK 300 million for securities issued in Norwegian kroner.
- Norges Bank has provided Norwegian krone loans against collateral in euros. These loans are also available to foreign banks that are not under Norway’s jurisdiction, but that are active in the Norwegian money market. Norges Bank provided loans in the amount of NOK 42.4 billion in such an operation on 10 October.
- Norges Bank has provided loans in US dollars to Norwegian banks. Banks access to US dollar funding in the market has in periods been impaired. Prices in the Norwegian money market depend on the availability of corresponding loans in US dollars at an observable price. On 16 September, the supply of dollars was restricted to the extent that banks stopped quoting Norwegian market rates. Norges Bank responded by providing USD 5 billion in loans to Norwegian banks against collateral in Norwegian kroner, enabling banks to resume quoting Norwegian interest rates. At the maturity date for these loans, Norges Bank provided a new loan. On 14 October, Norges Bank auctioned off a 1-week loan in US dollars against collateral in securities.
- Norges Bank has concluded a swap agreement with the Fed authorising a loan of USD 15 billion against collateral in Norwegian kroner. The agreement strengthens Norges Bank’s room for manoeuvre to address the turbulence in financial markets to the end of the year and into next year.
- The government will present a proposal to the Storting (Norwegian parliament) for establishing a new swap facility enabling banks to swap Norwegian residential mortgage-backed securities (RMBS) – coverd bonds - for Norwegian government bonds for an agreed period. The government will exchange the collateral of government securities in return for the collateral of RMBSs. The new government bonds are in amounts up to NOK 350 billion and can be used as collateral for new long-term funding by banks, be sold, or used as collateral for loans in the money market.
- Growth prospects abroad have considerably worsened. Inflation expectations have fallen.
- Premiums in money markets in the US, the euro area and the UK have increased further. In the US, the premium in three-month money market rates has increased by about 1.9 percentage points to about 3.5 percentage points. In the euro area, the premium is now close to 1.7 percentage points, while it is about 2.2 percentage points in the UK. In Norway the premium in the three-month money market is about 1.6 percentage points.
- Three-month money market rates in Norway have varied between 7.91 and 6.75 per cent since the beginning of October. Interbank lending is increasingly concentrated at the shortest maturities. Liquidity in the interbank market is very tight. US dollars are in particularly short supply, especially during European business hours. This has resulted in wide swings and high premiums in short-term interest rates.
- Norwegian banks’ weighted lending rate on new home mortgages with sound collateralisation has increased by close to 0.4 percentage point to almost 7.8 per cent.
- Equity prices have fallen markedly in Norway and abroad. The Oslo Stock Exchange benchmark index has fallen by 23 per cent since the monetary policy meeting in September and 49 per cent since the peak in May.
- Oil prices have continued to fall. The spot price of Brent Blend oil is USD 72 per barrel. The average futures price for delivery in 2009 is USD 83 per barrel.
- The Economist commodity-price index has fallen by 12 per cent measured in XDR (1). By the same measure, food prices have fallen by 12 per cent and the price of fresh salmon by 8 per cent, while the price of frozen salmon has fallen by 9 per cent. Industrial metals prices have fallen by 12 per cent measured in XDR, and the price of aluminium has fallen by 6 per cent. Dry cargo freight rates have fallen by 59 per cent in XDR terms.
- The krone exchange rate has continued to depreciate. Risk appetite among market participants is low. This has contributed to net sales of NOK. The decline in prices for oil and other commodities may also be exerting depreciation pressure on the krone. The import-weighted krone exchange rate is now about 3.0 per cent weaker than at the time of the previous monetary policy meeting.
- The year-on-year rise in the consumer price index (CPI) was 5.3 per cent in September. Adjusted for tax changes and excluding temporary changes in energy prices (CPIXE), consumer prices rose by 3.7 per cent over the past 12 months (2). Adjusted for tax changes and excluding energy products (CPI-ATE), consumer price inflation was 3.1 per cent. Measured by a trimmed mean of the 12-month rise in the sub-indices in the CPI, inflation was 3.9 per cent in September, while a weighted median showed a rise of 3.1 per cent.
- In the central government budget proposal for 2009, the structural non-oil deficit for 2009 is estimated at NOK 92 billion. This corresponds to the expected real return on the Government Pension Fund – Global. As a percentage of mainland trend GDP, the deficit will then increase by 0.7 percentage point between 2008 and 2009. The estimate for the non-oil deficit for 2009 is NOK 48.7 billion. Nominal growth in the central government’s underlying spending is estimated at 7.8 per cent.
- In September, seasonally adjusted registered unemployment stood at 1.7 per cent of the labour force, 0.1 percentage point higher than in August. According to Statistics Norway's labour force survey (LFS), seasonally adjusted unemployment was 2.4 per cent in July, down from 2.5 per cent in the previous month. Employment rose by 2000, while the labour force contracted by 2000 in the same period.
- Seasonally adjusted manufacturing production was approximately unchanged in the period June-August compared with the previous three months.
- Mainland enterprises’ gross domestic debt rose by 18.7 per cent in the year to July 2008, up from 17.2 per cent in June. The growth in money supply to the enterprise sector was 3.9 per cent in the year to August 2008.
- According to household financial accounts, household net lending stood at a negative NOK 59.5 billion summed over the last four quarters to the second quarter of this year. Household net assets were NOK 112.8 billion lower in the second quarter of this year than in the second quarter of last year. Household gross domestic debt was at the end of August 9.1 per cent higher than at the same time last year. Annualised, household gross domestic debt grew at a rate of 7.4 per cent in the period June-August compared with the previous three months.
- Household spending on goods rose by a seasonally adjusted 0.2 per cent from July to August, after falling by 1.2 per cent from June to July. In August, goods consumption was 3.7 per cent below the level in August last year.
- According to the real estate industry’s house price statistics, house prices fell by a seasonally adjusted 0.8 per cent from August to September. This was the sixth consecutive month of decline. Prices were 4.5 per cent lower than in September 2007. Building statistics show that housing starts in square metres fell by 7.1 per cent in the year to August 2008. In the same period, starts of buildings other than dwellings increased by 20.8 per cent
Despite comprehensive measures by the authorities, the problems that arose in the US banking system have spread to most markets and countries, particularly after 15 September. High counterparty and settlement risk has markedly reduced banks’ willingness to lend to each other. Credit channels have dried up. Equity prices have fallen sharply. The outlook for global economic growth next year has considerably worsened. Oil and commodity prices have fallen. Many countries have reduced their key rates.
The slowdown in the Norwegian economy appears to be occurring faster and to be more pronounced than previously projected. Inflation remains high, but the forces that have fuelled inflation have now diminished. The supply of capital has declined and it is more expensive and to some extent more difficult for banks, enterprises and households to obtain funding. Banks have increased their lending rates. Pricing in the market indicates that interest rate premiums may remain high for a period ahead and that it will take time to restore confidence between banks. Still, the actions taken by the government and Norges Bank are now curbing the fluctuations.
The Executive Board’s strategy is that the key policy rate should be in the interval 5¼ – 6¼ per cent in the period to the publication of the next Monetary Policy Report on 29 October, unless the Norwegian economy is exposed to major shocks. The Norwegian economy is now exposed to fairly major shocks. The monetary policy meeting on 29 October will proceed as planned, and the Board will then take a stand on the key policy rate and the strategy ahead.
At the monetary policy meeting on 24 September, we highlighted that it was difficult to determine how long the volatility would last and the effects on inflation and activity in the Norwegian economy. The crisis in financial markets has deepened and will therefore have greater effects on the Norwegian economy than previously assumed. There is now unusually high uncertainty about developments ahead. It is difficult to comment on the likelihood of different outcomes. In such times of decision making, the most robust approach may be to implement measures that can reduce the uncertainty and stave off particularly adverse outcomes for the economy. This now implies a more active monetary policy than normal, both in interest-rate setting and through liquidity policy measures.
The Norwegian authorities have implemented a broad range of measures to address the situation in money and credit markets. Changes in Norges Bank’s key policy rate will not in isolation restore the flow of credit in the financial sector. The key policy rate is set with a view to stabilising developments in inflation, output and employment. An overall assessment of the outlook and risk indicates that it is appropriate to reduce the key policy rate by 0.50 percentage point to 5.25 per cent at this meeting.
The key policy rate is reduced by 0.50 percentage point to 5.25 per cent with effect from 16 October 2008.
1) Special drawing rights, IMF. Currently, XDR is comprised of 40 per cent USD, 39 per cent EUR, 11 per cent GBP and 10 per cent JPY. As of 13 October XDR 1 = NOK 9.22.
2) The figure for the CPIXE in September is based on information on futures prices for oil and electricity in the last ten trading days in September.