Monetary Policy Report with financial stability assessment is published four times a year, in March, June, September and December. The Report assesses the interest rate outlook and forms the basis for Norges Bank’s advice on the level of the countercyclical capital buffer. The Report includes projections of developments in the Norwegian and global economy.

Editor: Øystein Olsen

Design: Brandlab

Printing: 07 Media AS

The text is set in 9.5 point Azo Sans Light

Photo: Esten Borgos

ISSN: 1894-0242 (print) | 1894-0250 (online)

NORGES BANK

Bankplassen 2, P.O. Box 1179 Sentrum, N-0107 Oslo, Norway

Phone: +47 22316000

www.norges-bank.no

Monetary Policy Report 1|19 – March

This Monetary Policy Report is based on information in the period to 15 March 2019 and was published on 21 March 2019, the day after the Executive Board’s monetary policy meeting.

The Report is available at www.norges-bank.no.

Executive Board’s assessment

Norges Bank’s Executive Board has decided to raise the policy rate by 0.25 percentage point to 1.0%. The Executive Board’s current assessment of the outlook and balance of risks suggests that the policy rate will most likely be increased further in the course of the next half-year.

Economic growth among Norway’s trading partners has slowed after a broad upswing over several years. Growth was weaker than expected in 2018 Q4, and the current growth projections are lower than in the December 2018 Monetary Policy Report. There are still prospects for higher price and wage inflation, but the projections have been revised down. Following a period of large movements in financial markets, global equity prices are now higher than in December. Forward rates indicate that policy rate expectations have fallen since December. Oil prices have risen since December, but futures prices are little changed.

Growth in the Norwegian economy has been solid since autumn 2016. Employment has risen, and unemployment has declined. The global upturn, higher oil prices and low interest rates have contributed to pushing up growth. The upturn in the Norwegian economy is expected to continue, partly fuelled by strong pick-up in investment on the Norwegian shelf in 2019. Further out, lower growth abroad and a decline in petroleum investment will weigh on growth.

Growth in the mainland economy was higher than expected in 2018 Q4. Norges Bank’s Regional Network contacts expect output growth to remain firm ahead. Petroleum investment appears to be higher in 2019 and 2020 than projected in December, but somewhat lower further out. Since the December Report, employment has risen more than projected, and unemployment has continued to drift down.

Consumer price inflation has risen over the past year, fuelled in part by higher electricity prices. Underlying inflation has also moved higher, partly reflecting higher wage growth. Tighter labour market conditions suggest that wage growth will increase further.

Inflation has been higher than projected in the December Report. In February, the 12-month rise in the consumer price index (CPI) was 3.0%. Adjusted for tax changes and excluding energy products (CPI-ATE), inflation was 2.6%. The krone exchange rate is weaker than expected. At the same time, profitability in some sectors, especially oil services, appears to be weaker than envisaged earlier. This may dampen the rise in wage growth ahead.

Persistently high debt growth has increased household vulnerability. Household debt growth has abated somewhat in recent years, but remains higher than growth in disposable income. House prices have risen recently, after showing little change through autumn 2018.

In its discussion of the risk outlook, the Executive Board focused in particular on global economic developments. Over the past year, rising protectionism and political uncertainty have weighed on global growth. Euro-area growth slowed markedly towards the end of 2018. The UK’s relations with the EU have yet to be clarified. If trade tensions deepen, growth among trading partners may be lower than projected. At the same time, the krone may remain weak, if global uncertainty persists. The Executive Board also noted that the upturn in the Norwegian economy may prove to be more pronounced than envisaged. Price and wage inflation may then turn out higher than projected.

The target for monetary policy is annual consumer price inflation of close to 2% over time. Inflation targeting shall be forward-looking and flexible, so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances.

In its assessment, the Executive Board notes that the monetary stance is accommodative. The Norwegian economy is expanding at a solid pace, and capacity utilisation now appears to be slightly above a normal level. Underlying inflation is a little higher than the inflation target. The uncertainty surrounding global developments and the effects of monetary policy suggests a cautious approach to interest rate setting. Overall, the outlook and the balance of risks imply a gradual interest rate increase ahead.

The upturn in the Norwegian economy appears to be stronger than anticipated earlier. On the other hand, there are prospects for weaker growth and lower interest rates abroad. The policy rate forecast indicates a slightly faster rate rise in 2019 and a somewhat lower policy rate further out than projected in the December Report. With this path for the policy rate, inflation is projected to be close to target in the years ahead, at the same time as unemployment remains low. The policy rate path will be adjusted in response to changes in economic prospects.

The Executive Board decided to raise the policy rate by 0.25 percentage point to 1.0%. The Executive Board’s current assessment of the outlook and balance of risks suggests that the policy rate will most likely be increased further in the course of the next half-year. The decision was unanimous.

Øystein Olsen

20 March 2019

Part 1: monetary policy

1 Overall picture

The upturn in the Norwegian economy continues. Employment is rising, and capacity utilisation appears to be slightly above a normal level. Consumer price inflation has risen over the past year, and underlying inflation is slightly above the 2% target.

The policy rate has been raised from 0.75% to 1%. In the forecast, the policy rate increases further in the course of the next half-year, reaching 1.75% at the end of 2022. The policy rate forecast is slightly higher in the next few years than in the December 2018 Monetary Policy Report, and slightly lower further out. The upward revision of the policy rate forecast at the start of the projection period partly reflects stronger domestic demand and a weaker krone. The downward revision further out reflects prospects for lower growth and a more gradual interest rate rise among trading partners.

With a policy rate in line with the forecast, inflation is projected to be close to target, at the same time as unemployment remains low.

1.1 Global developments and outlook

Weaker global growth

After the recent years’ broad upswing, GDP growth has slowed in a number of trading partner countries (Chart 1.2), and has been a little lower than projected in Monetary Policy Report (MPR) 4/18, published on 13 December. Growth has softened over the past year on the back of tighter financial conditions, increased uncertainty associated with trade tensions and the UK’s exit from the EU. GDP growth among trading partners is expected to rebound slightly ahead. The projections for GDP growth and import growth among trading partners are nevertheless lower than in the December Report.

Lower inflation

Underlying inflation among Norway’s trading partners has been stable at somewhat below 1.5% since the beginning of 2017. Recently, inflation has been lower than expected, while wage growth has picked up broadly as projected. Both wage growth and underlying inflation are projected to move up in the next few years owing to higher capacity utilisation, but the projections are lower than in the December Report.

Central bank policy rates have been raised in a number of countries (Chart 1.3). At the same time, the global interest rate level remains low, and forward rates among Norway’s main trading partners indicate a very gradual rate rise ahead. Interest rate expectations have fallen since December.

Oil spot prices are now around USD 65 per barrel, somewhat higher than in December (Chart 1.4). Futures prices are little changed and indicate a slight decline in oil prices in the period to 2022.

1.2 The economic situation in Norway

Solid growth in the Norwegian economy

The global upturn, higher oil prices and low interest rates have contributed to solid growth in the Norwegian economy over the past few years. After falling sharply for several years, investment on the Norwegian shelf and oil service exports expanded in 2018.

Growth in mainland GDP picked up in 2018 Q4 and was higher than projected in the December Report. Growth in the mainland economy is projected to be firm over the next two quarters (Chart 1.5). The projections are in line with the expectations of enterprises in Norges Bank’s Regional Network and the projections from Norges Bank’s System for Averaging short-term Models (SAM). The projections for the first half-year have been revised up slightly compared with the December Report.

Employment growth is solid (Chart 1.6), and unemployment has fallen further. Labour market developments in recent months have been better than projected and may suggest that capacity utilisation is a little higher than assumed in the December Report.

Household debt growth has slowed through 2018. House prices have risen slightly more than expected in recent months, after having shown little change through autumn 2018.

Higher-than-expected inflation

Consumer price inflation has picked up over the past year. Inflation has been higher than projected in the December Report. In February, the 12-month rise in the consumer price index (CPI) was 3.0% (Chart 1.7). CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) was 2.6%.

Annual wage growth in 2018 was 2.8%, in line with the wage settlement norm and a little higher than projected in December. Wage growth is expected to increase further in 2019.

The krone has appreciated so far in 2019, after weakening towards the end of 2018, but the krone has been weaker than projected in December.

1.3 Monetary policy and projections

Prospects for higher interest rates

The operational target of monetary policy is annual consumer price inflation of close to 2% over time. Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances.

Monetary policy is expansionary. The outlook for the Norwegian economy suggests that the policy rate should be raised ahead. A policy rate that is too low over time may increase pressures in the economy, triggering acceleration in price and wage inflation. Raising the policy rate too rapidly may stifle the upturn, resulting in higher unemployment and below-target inflation. The uncertainty surrounding global developments and the effects of monetary policy suggests a cautious approach to interest rate setting.

The policy rate has been raised from 0.75% to 1%, effective from 22 March 2019. In the forecast, the policy rate increases further in the course of the next half-year, reaching 1.75% at the end of 2022. With a policy rate in line with the forecast, inflation is projected to be close to target, at the same time as unemployment remains low.

The rate path is slightly higher than in the December Report in the next few years and slightly lower further out (Chart 1.1a). The upward revision of the policy rate path at the start of the projection period reflects stronger domestic demand and a weaker krone. The downward revision further out reflects prospects for lower growth and a more gradual rate rise among trading partners.

The policy rate forecast implies an increase in residential mortgage rates from 2.6% to around 3.5% in the course of the projection period (Chart 1.8).

The projections are uncertain, and uncertainty increases through the projection period. The forecast shows the policy rate outlook given economic developments in line with the current projections. If developments take a different course, the rate path will be adjusted.

MONETARY POLICY SINCE DECEMBER

At the monetary policy meeting on 12 December, the policy rate was kept unchanged at 0.75%. The analyses in the December 2018 Monetary Policy Report indicated a further rate hike in March, followed by a gradual rise to 2% at the end of 2021. With this path for the policy rate, inflation was projected to be close to target and unemployment to remain low.

At the monetary policy meeting on 23 January, new information was assessed in relation to the projections in the December Report. Global growth had been a little weaker than projected. At the same time, inflation in Norway had been a little higher than expected, while economic growth and labour market developments appeared to be broadly as projected. The Executive Board’s assessment in January was that the outlook and balance of risks had not changed substantially since December. The Executive Board decided to keep the policy rate unchanged at 0.75%.

Higher capacity utilisation and inflation close to target

With the policy rate in line with the forecast, capacity utilisation is likely to continue to rise and remain above a normal level throughout the projection period (Chart 1.1b). Capacity utilisation is projected to peak in the first half of 2020, gradually declining thereafter. Compared with the December Report, the projections for capacity utilisation have been revised up slightly. The krone is expected to appreciate ahead, but will remain weaker than projected in the December Report throughout the projection period (Chart 1.9).

Rising capacity utilisation will likely push up inflation, while a stronger krone will restrain the rise. Inflation is projected to be at around 2% at the end of 2022 (Charts 1.1c-d). Compared with the December Report, the inflation projections are higher throughout the projection period.

Growth in mainland GDP is projected at 2.7% in 2019 (Chart 1.10). In the years ahead, growth will decelerate on the back of higher interest rates, a gradual appreciation of the krone and lower petroleum investment. The deceleration also reflects expectations that growth abroad will be lower than in recent years. Compared with the December Report, growth is projected to be higher in 2019 and 2020, but a little lower in 2021.

Household consumption growth is expected to be moderate. Despite higher interest rates, household real disposable income is set to be higher in the years ahead, owing to prospects for real wage growth and continued employment growth. Business investment is expected to rise further in pace with higher capacity utilisation. Mainland exports are also expected to increase in the years ahead, driven in part by higher global oil investment. Investment on the Norwegian shelf is expected to rise considerably in 2019 and edge slightly higher in 2020, before falling further out in the projection period (Chart 1.11). Growth in public demand is expected to slow ahead.

Wage growth on the rise

Employment is expected to rise through the projection period, in pace with the upturn in the mainland economy. The projections are a little higher than in December. The labour force is also expected to expand, but less than employment, so that unemployment will show a small decline in the coming year (Chart 1.12).

Tighter labour market conditions are expected to push up wage growth further (Chart 1.13).

2 The global economy

After the recent years’ broad upswing, GDP growth among Norway’s trading partners has now slowed. Growth slowed through 2018 on the back of tighter financial conditions and growing uncertainty about economic and political developments. The projections for GDP growth among trading partners are lower than in the December 2018 Monetary Policy Report. The projections for wage growth and underlying inflation abroad are also lower than in the December Report. Oil spot prices have increased since December, while futures prices show little change. Expected money market rates and long-term rates among trading partners have declined.

2.1 Growth, prices and interest rates

Slightly weaker growth prospects

GDP growth in many of Norway’s trading partners has slowed, for example in Europe, the US and some emerging economies. Growth has slowed slightly more than projected in December, particularly in the euro area. Activity indicators for manufacturing and services are lower than in December (Chart 2.1).

Uncertainty surrounding the economic outlook has contributed to large movements in financial markets since the December Report. The Federal Reserve has signalled that it intends to wait and see before changing rates further. Expected money market rates among main trading partners indicate a very gradual rate rise, and interest rate expectations have declined since the December Report (Chart 2.2). Long-term interest rates have also fallen since December (Chart 2.3). After declining in December, global equity prices are now higher than at the time of the December Report (Chart 2.4). Overall financial conditions among main trading partners are slightly looser than in December.

Tighter financial conditions and mounting uncertainty linked to trade tensions and the UK’s exit from the EU led to a gradual deterioration in growth prospects through 2018. This uncertainty is expected to continue to weigh on growth in 2019, particularly as a result of reduced businesses investment willingness. At the same time, expansionary monetary and fiscal policies and the oil price decline in autumn 2018 are underpinning growth, and GDP growth among trading partners is expected to edge up a little ahead. Capacity utilisation among trading partners is projected to be close to a normal level in the coming years. GDP growth and import growth are projected to be lower than in the December Report (Chart 2.5 and Annex Table 1).

Lower price inflation

Overall price inflation for Norway’s main trading partners has fallen more than expected, primarily reflecting lower energy price inflation after the oil price decline in autumn 2018. Underlying inflation has remained stable somewhat below 1.5% since the beginning of 2017 (Chart 2.6), but has been slightly lower than expected recently. The inflation projections for 2019 have been revised down since the December Report. Wage growth among trading partners was low for a long time despite a marked fall in unemployment. Since spring 2018, wage growth has picked up. Wage growth and underlying price inflation are both projected to show a small increase in the next few years as a result of the rise in capacity utilisation (Chart 2.7 and Annex Table 2). The projections are lower than in December. Oil spot prices are now around USD 65 per barrel, somewhat higher than in December. Futures prices up to 2022 are little changed (Chart 1.4). Oil prices are discussed in "Developments in oil and Natural gas prices".

The rise in prices for Norwegian imported consumer goods in foreign currency terms has been higher than projected in December, particularly for audio-visual equipment and clothing and footwear. The projections for import price inflation in 2019 have been revised up (Chart 2.8). The shift in Norwegian imports towards low-cost countries such as China and other emerging economies is expected to diminish in the years ahead, but to continue to dampen imported consumer goods inflation.

Global outlook remains highly uncertain

There is considerable uncertainty surrounding global economic developments. If trade tensions deepen, growth may prove lower than projected. The UK’s relations with the EU have yet to be clarified, and continued uncertainty about the outcome may result in lower growth in Europe than expected. On the other hand, economic growth may prove stronger than projected if, for example, the US and China sign a trade agreement or the political processes in Europe rapidly lead to sound solutions.

2.2 Countries and regions

Slowdown in US growth

The US economy expanded at a fast pace through much of 2018, primarily driven by an expansionary fiscal stance. In the past few months, growth has slowed somewhat and been slightly weaker than projected in the December Report. This partly reflects the five-week government shutdown owing to the disagreement over the 2019 budget. Employment growth has been high, and wage growth has accelerated to a little more than 3%.

The Federal Reserve raised its policy rate in December to a target range of 2.25–2.50%, and signalled at its January meeting that it would wait and see before changing rates further owing to increased uncertainty. Forward rates do not indicate further rate hikes ahead. Policy rate expectations in 2022 are 0.3 percentage point lower than in December. The monetary policy signals have contributed to a somewhat weaker USD effective exchange rate.

Capacity utilisation is estimated to be well above a normal level, and rising capacity constraints are expected to push down growth ahead. In addition, investment growth is expected to lose some momentum as a result of a likely fading of the effects of previous corporate tax cuts and the uncertainty associated with trade tensions. GDP growth is now projected to slow gradually from 2.9% in 2018 to 1.7% in 2022. The projections are slightly lower than in the December Report. Consumer price inflation has been lower than expected as a result of stronger effects of the oil price decline towards the end of 2018 than envisaged earlier. The projections for both price and wage inflation have been revised down a little as lower GDP growth is expected to contribute less to labour market pressures than previously assumed.

Lower growth in the euro area

Euro-area GDP growth appears to be slowing further in 2019, after having gradually tapered off in 2018. Uncertainty about the UK’s exit from the EU and trade tensions have contributed to dampening growth. Temporary factors affecting German manufacturing also pushed down on growth in the latter half of 2018. Household confidence indicators and business activity indicators have edged down since December. On the other hand, unemployment has continued to decline, and wage growth is moving up (Chart 2.9). Capacity utilisation is estimated to be close to a normal level.

The European Central Bank (ECB) terminated its net asset purchases in December 2018. Against the background of weaker economic developments, the ECB has signalled a rate rise in 2020 at the earliest. Policy rate expectations have also edged down since December. Forward rates indicate that the first rate rise is expected in summer 2020.

GDP growth is projected to increase from 1.1% in 2019 to 1.5% in 2021. Growth is mainly driven by the increase in consumer purchasing power, while uncertainty associated with trade tensions will likely continue to restrain business investment willingness ahead. Compared with the December Report, the growth projections have been revised down. Underlying inflation is expected to rise gradually in the coming years as a result of higher capacity utilisation and rising wage growth. Owing to the slowing of GDP growth, the projections for price and wage inflation have been revised down. Overall annual price inflation is expected to remain below 2% to the end of the projection period.

Substantial uncertainty in the UK

UK growth slowed markedly towards the end of 2018. The slowdown likely reflects heightened uncertainty about the UK’s future relations with the EU. The UK Parliament has not approved the Withdrawal Agreement with the EU, and the UK’s relations with the EU have yet to be clarified. Business investment has fallen in recent quarters, and business and household prospects have weakened considerably (Chart 2.10). At the same time, labour market conditions are still tight. Unemployment is now at its lowest level since 1975, and wage growth has accelerated to close to 3.5%. The Bank of England continues to signal that a gradual tightening of monetary policy is necessary to stabilise inflation around target. Forward prices indicate little change in policy rate expectations since December.

This Report applies the assumption that the UK’s exit from the EU will be orderly. Investment is expected to rebound as uncertainty recedes and future trade relations are clarified. A more expansionary fiscal policy and prospects for higher real wage growth will also underpin growth. GDP growth is expected to pick up from 1.1% in 2019 to 1.5% in 2021, while capacity utilisation remains close to a normal level. Price inflation has been a little lower than envisaged in the December Report, and the projection has been revised down for 2019. Annual inflation is projected, as previously, at around 2% in the period ahead.

Lower growth in Sweden

Swedish GDP growth picked up in 2018 Q4 following negative growth in Q3. Confidence and activity indicators have fallen, but most indicators remain at high levels. Capacity utilisation remains higher than normal. Inflation, as measured by the consumer price index with a fixed interest rate (CPIF), is close to the inflation target of 2%. The Riksbank raised its policy rate in December. At its meeting in February, the Riksbank signalled one rate hike in 2019 and two further rate hikes in 2020. Policy rate expectations have fallen somewhat since December and forward rates indicate a rate hike towards the end of 2019.

GDP growth in 2018 Q4 was higher than projected in the December Report, but weaker growth in housing investment and more moderate growth among Sweden’s trading partners will likely curb growth in the coming years. Later in the projection period, stronger wage growth pushes up consumption and growth. GDP growth is projected to rise gradually from 1.6% in 2019 to 2% towards the end of the projection period. The projections are lower than in the December Report. Inflation is projected to remain close to target in the coming years.

Trade tensions drag down Chinese growth

Chinese GDP growth continued to slow in 2018 Q4. Growth in both exports and imports slowed towards the end of the year, and manufacturing activity declined (Chart 2.11). GDP growth was nevertheless somewhat stronger than envisaged in December.

Trade tensions between China and the US have likely contributed to the slowdown in Chinese growth and to heightened uncertainty surrounding the outlook. However, the Chinese government has increased infrastructure investment and taken measures to boost household consumption with a view to stimulating the economy. A more expansionary monetary and fiscal stance is expected to mitigate the negative effects of the trade conflict. As in the December Report, growth is projected to drift down to 6% in 2019 and hover just below 6% to the end of the projection period.

The effects of lower activity in China and trade tensions have spilled over into other emerging economies. The effects vary widely across countries and are not negative for all emerging economies. For example, Brazil and India have increased their market share for various goods as a result of the new trade restrictions between China and the US. The fall in oil prices in autumn 2018 has contributed to curbing price inflation and provided additional room for monetary policy stimulus in a number of countries. A less tight monetary policy outlook in the US has also helped ease financial conditions. Overall, the growth projections for emerging economies excluding China are slightly lower than in the December Report.

Developments in oil and Natural gas prices

Oil spot prices are now USD 66 per barrel, USD 5 higher than at the time of the December Monetary Policy Report. Prices fell to just above USD 50 in December, in an environment of weaker global developments and financial market turbulence. In addition, OECD oil inventories increased towards the end of 2018 (Chart 2.12), following record-high oil production in countries such as Saudi Arabia, Russia and the US through autumn.

Since the turn of the year, oil prices have risen again, as global equity prices rebounded and financial market uncertainty subsided. However, the rise is also related to supply-side conditions. OPEC+ has again cut production substantially.1 Production has also declined further in Iran and Venezuela. Combined, this has more than offset the continued rise in US oil production. At the same time, global oil consumption has continued to grow at a steady pace, despite slowing global growth and uncertainty about the outlook. Growth in oil consumption is particularly high in countries such as China, India and the US.

Oil prices are assumed to move in line with futures prices (Chart 1.4). Futures prices at end-2022 are a little higher than USD 60, about the same as in December.

Oil prices may turn out to be higher or lower than currently envisaged. Lower oil supply could push up prices. In addition to production cuts by OPEC+, sanctions against Iranian oil exports may be increased. A further decline in oil production in Venezuela could depress global oil supply even further. OECD oil inventories could then fall again. On the other hand, prices could fall if US oil production increases at a faster pace than expected. In addition, global oil consumption growth may decline if growth in the world economy proves to be lower than expected, especially if growth in emerging economies, such as China and India, slows more than anticipated. Over time, demand may also shrink as a result of energy efficiency measures and a shift towards new energy sources in order to meet long-term climate goals.

European natural gas prices have declined further since the December Report (Chart 2.13), reflecting lower natural gas prices in Asia, ample access to liquefied natural gas in Europe and generally weaker economic developments in the euro area and in the UK. In addition, coal prices have also edged lower. Natural gas prices are assumed to move in line with futures prices, which are lower in the coming years than envisaged in December.

1 Twelve OPEC countries and 10 non-OPEC countries agreed to cut back production at meetings in December 2018 (see press release). The OPEC member country Saudi Arabia and Russia (as representative of non-OPEC countries) are particularly important parties to the agreement.

3 The Norwegian economy

Growth in the Norwegian economy is solid, and employment is rising. Unemployment has declined, and capacity utilisation appears to be slightly above a normal level. Inflation has risen over the past year. Underlying inflation is slightly above the inflation target of 2%.

Mainland GDP rose by 2.5% in 2018 and is projected to rise by 2.7% in 2019. This is higher than the economy’s estimated growth potential, and growth is expected to slow further out in the projection period. Higher interest rates, a gradual appreciation of the krone and a decline in oil investment will restrain growth. Capacity utilisation is projected to rise in the period to the first half of 2020 before edging down gradually. Unemployment is expected to remain low and wage growth to pick up. Inflation is projected at 2% at the end of 2022.

3.1 Output and demand

Solid growth in the Norwegian economy

Growth in the mainland economy has been solid since autumn 2016. The global upturn, higher oil prices and low interest rates have contributed to driving growth. After falling sharply for several years, investment on the Norwegian shelf and oil service exports expanded in 2018.

Mainland GDP growth was 0.9% in 2018 Q4, higher than projected in the December Report. Agricultural production pulled up mainland GDP by 0.2% after a corresponding negative contribution in 2018 Q3 owing to the dry summer (Chart 3.1). Monthly national accounts indicate that growth was a little lower in January than through 2018 Q4.

In February, Norges Bank’s Regional Network contacts reported that growth in the past three months was at approximately the same level as in the preceding three months (Chart 3.2). While oil service contacts reported that growth had picked up markedly, contacts in the construction industry and distributive trade reported slower growth. Overall, contacts expected that growth would remain at approximately the same level over the next half-year.

REGIONAL NETWORK

Norges Bank has regular contact with a network of business leaders. The purpose is to gather information on economic developments in their businesses and industries. The network consists of around 1 500 enterprises, and each enterprise is contacted about once a year. A round of interviews is conducted each quarter, and more than 300 network contacts participate in each round.

The contacts represent enterprises in the Norwegian business sector and the local government and hospital sector that reflect the production side of the economy both sector-wise and geographically.

Growth in the mainland economy is projected to be solid in the coming two quarters, (Annex Table 3a). The projections are in line with Regional Network expectations and the projections from Norges Bank’s System for Averaging short-term Models (SAM) (Chart 1.5). Compared with the December Report, the projections for the first half of 2019 have been revised up a little.

Annual growth in mainland GDP is projected to rise from 2.5% in 2018 to 2.7% in 2019 (Chart 1.10). The figures have been adjusted for the variation in the number of working days per year. In 2019, exports, oil investment and business investment will make a substantial contribution to growth in the mainland economy.

Further out in the projection period, growth is expected to decelerate on the back of higher interest rates, a gradual appreciation of the krone and lower oil investment (see "Financial conditions" and "Projections for petroleum investment"). The deceleration also reflects expectations that growth abroad will be lower than in recent years. Fiscal policy ahead is assumed to be less expansionary than in recent years (see "Assumptions concerning fiscal policy").

Compared with the December Report, the growth projections have been revised up somewhat for the projection period as a whole, reflecting a weaker projection for the krone than in December and a somewhat higher oil price. Growth among Norway’s trading partners has been revised down and pulls in the opposite direction.

Prospects for further growth in household consumption

Consumption growth slowed slightly in 2018. After falling in 2018 Q3, consumption rebounded in Q4. Developments were broadly as projected in the December Report. Consumption growth is expected to pick up further in the coming period. Consumer confidence indicators have declined a little since December, but are close to their historical average (Chart 3.3).

Real income growth rose on the back of solid employment growth in 2018. Lower-than-expected tax payments contributed to appreciably higher real disposable income than assumed in the December Report. Higher wage growth lifts income growth ahead. Higher interest rates curb the rise in disposable income. Owing to high household debt ratios, the impact will be stronger than during previous periods of interest rate rises.

Prospects for rising real wage growth and continued employment growth imply higher consumption growth in the coming years (Chart 3.4). Consumption growth is projected to increase somewhat in 2020 and then remain broadly unchanged. Compared with the December Report, the projections are slightly higher for 2020 and 2021, reflecting higher real income than assumed in December.

Saving is projected to remain fairly stable through the projection period (Chart 3.5).

Moderate house price inflation

House price inflation has picked up slightly through winter. In February, the twelve-month rise was 3.0% (Chart 3.6), slightly higher than projected in the December Report.

Recently, activity in the market for existing homes has been high. The stock of unsold homes is declining, but is still at a high level. At the same time, new housing completions have picked up, and there are prospects of a large number of housing completions in the course of 2019, which will likely pull down on house price inflation.

Prospects for increased employment and higher wage growth ahead suggest in isolation rising house price inflation, while higher interest rates will dampen the rise. Overall, house price inflation is projected to be moderate through the projection period (Chart 3.7). Compared with the December Report, the projections for house price inflation are slightly higher in 2019 and little changed further out in the projection period. The housing market is discussed in Section 5.3.

Increased housing investment

Housing investment fell markedly from autumn 2017 until summer 2018, but has shown little change since then. Housing investment in 2018 was higher than projected in December.

Prospects for growth in real house prices suggest a slight increase in housing investment through the projection period (Chart 3.8). New home sales have been fairly stable over the past two years, but clearly lower than in 2016 when housing investment rose markedly. Centralisation has accelerated in recent years, which may increase demand for dwellings surrounding urban areas. On the other hand, slower population growth and prospects for higher residential mortgage rates will likely dampen housing investment growth. Compared with the December Report, the investment projections have been revised up.

Higher business investment ahead

Following strong growth in 2016 and 2017, business investment increased moderately in 2018. The increase was somewhat stronger than projected in the December Report. Investment growth was considerable in the power, manufacturing and mining sectors (Chart 3.9). At the same time, services investment fell after having grown markedly in 2016 and 2017.

Growth in business investment is expected to pick up in 2019, and the projection has been revised up somewhat in the light of the Statistics Norway’s investment intentions survey. The survey indicates strong growth in manufacturing and mining. Investment in the power sector is projected to fall, but increasing investments in wind power development will dampen the decline. Contacts in Norges Bank’s Regional Network reported in February that investment growth was expected over the next twelve months.

A continued upturn in the Norwegian economy points to higher business investment in the years ahead (Chart 3.10). Higher interest rates pull down on growth. Substantial business investment in recent years may also dampen the need for investment in the period ahead. The projections have been revised up somewhat since December, partly reflecting higher-than-expected capacity utilisation.

Prospects for higher exports

Norwegian exports have been sluggish in recent years despite a substantial improvement in cost competitiveness since 2013 (Chart 3.11). Mainland exports declined in 2016 and 2017, largely reflecting the fall in oil service exports owing to the decline in global petroleum investment. In addition, some raw material exports declined owing to supply-side disturbances.

In 2018, oil service exports picked up, albeit somewhat less than projected in the December Report. Non-oil mainland exports also increased slightly less than anticipated. Regional Network contacts expected that growth in both oil service exports and other export industries would pick up in the near term (Chart 3.12).

The rise in oil service exports is expected to continue in the years ahead, driven by an upswing in global offshore investment. Non-oil mainland exports are also expected to grow, particularly in the manufacturing segments that invest in added production capacity. Growth in overall mainland exports is projected to rise in 2019 (Chart 3.13), slowing thereafter owing to a gradual appreciation of the krone.

The projections for export growth are somewhat lower than in the December Report, mainly reflecting a downward revision in growth projections for Norway’s trading partners. At the same time, the krone exchange rate is projected to be weaker than envisaged in December, which in isolation pushes up the export projections.

Import growth has been low in recent years, reflecting the decline in petroleum investment. Oil and non-oil business investment tends to have a high import content. An expected strong rise in business investment in 2019 therefore points to higher import growth in 2019. Import growth is expected to remain firm after 2019. Lower growth in the Norwegian economy points to declining import growth, but the expected appreciation of the krone points to a shift in demand towards imports. The projections for import growth are little changed since December.

The projections are uncertain

The Norwegian economy may grow faster than projected. Historical experience suggests that business investment can increase substantially in upturns. A high level of activity and higher oil company profitability may have spillover effects into the mainland economy that are more pronounced than assumed. On the other hand, rising global protectionism and uncertainty about the UK’s exit from the EU may dampen global growth more than envisaged. This may lead to weaker demand for Norwegian exports and lower oil prices. It is also uncertain how households will respond to higher interest rates.

3.2 Labour market and output gap

Tighter labour market

Employment growth is solid (Chart 3.14). According to the quarterly national accounts (QNA), the number of employed has increased by around 100 000 persons since the start of the upturn in 2016. Over the past year, employment has risen in most sectors of the Norwegian economy, including oil-related industries. One exception is distributive trade where employment has remained unchanged over the past year. Since the December Report, overall employment has risen more than projected.

Employment growth is projected to continue in the coming period although growth is expected to slow slightly. In February, Regional Network contacts expected employment growth to remain firm in the coming three months (Chart 3.15). Norges Bank’s expectations survey indicates that employment growth will drift down ahead. The number of vacancies edged down between 2018 Q3 and 2018 Q4, after rising substantially through 2017 and in the first three quarters of 2019.

The rise in employment has been followed by a decline in unemployment. From the beginning of 2016 to summer 2018, registered unemployment decreased (Chart 3.16). Changes in the routines of the Norwegian Labour and Welfare Administration (NAV) contributed to a slight rise in registered unemployment in July 2018. Since then, seasonally adjusted unemployment has slowed slightly, corrected for a new change in NAV’s routines in November 2018. Registered unemployment was 2.3% in February. Unemployment was projected to remain unchanged at 2.4% in the December Report. In addition, the number of persons participating in labour market programmes has declined in recent months.

The number of unemployment benefit recipients as a share of the labour force has also declined further in recent months and confirms the impression of a continued improvement in the labour market (Chart 3.17). The share of unemployment benefit recipients is at its lowest level since 2009. The number of redundancies also appears to be declining. Downsizing notified to NAV is now at the same level as in the period leading up to the oil price fall in 2014. Registered unemployment is projected to show little change in the coming months (Annex Table 3b).

According to the Labour Force Survey (LFS), unemployment has also declined since the December Report. In December, LFS unemployment was 3.7%, which is lower than projected. The decline reflects fewer people entering the labour market. Developments must be viewed in the light of substantial uncertainty associated with LFS, which is a sample survey. Normally the number of job-seekers rises when job prospects improve, and in the December Report the labour force was therefore projected to grow. LFS unemployment is expected to move in line with registered unemployment in the coming months (Annex Table 3c).

Prospects for further employment growth

With prospects for a further upturn in the mainland economy, solid growth in employment is expected in 2019, followed by a gradual decline in employment growth owing to slowing mainland GDP growth. The employment growth projections are slightly higher than in the December Report through 2019 and are little changed thereafter. The number of employed is projected to rise by about 60 000 persons between the end of 2018 and the end of 2022.

In the years ahead, higher labour demand is expected to contribute to higher labour force growth, with a markedly smaller decline in unemployment than implied by employment growth in isolation. Unemployment is expected to edge down in the coming year, followed by a small increase (Chart 1.12). The projections for unemployment are slightly lower than in the December Report.

Positive output gap

In the years since the oil price fall in 2014, capacity utilisation has been below a normal level. In the Bank’s estimation, the cyclical trough was reached in summer 2016 and capacity utilisation has since been on the rise (Chart 1.1b). In December, the assessment was that the output gap was closing.

A number of signs indicate that capacity utilisation has continued to rise in recent months and that the output gap is now closed. Owing to solid employment growth, the number of employed persons as a share of the working-age population has increased (Chart 3.18). The employment rate is now close to its estimated long-term trend. Unemployment has drifted down further, and registered unemployment appears to be slightly lower than the level projected to be consistent with normal capacity utilisation. Owing to changes in NAV’s routines, there is more uncertainty than previously about developments in unemployment. LFS unemployment has fallen, but continues to indicate that capacity utilisation is slightly lower than normal. In February, feedback from the Regional Network survey showed an increase in the share of enterprises reporting capacity constraints (Chart 3.19). This share is higher than its historical average. The share reporting labour shortages, on the other hand, has been unchanged since November and remains lower than its historical average. Model estimates, which include a number of labour market indicators, imply that capacity utilisation rose between 2018 Q3 and 2018 Q4 (Chart 3.20) and is now close to a normal level.

Overall, the output gap is estimated to have closed at the end of 2018, and capacity utilisation has continued to increase into 2019. The employment rate is assessed to be close to the highest level consistent with price stability over time. Capacity utilisation is expected to continue to rise over the coming quarters, with the output gap gradually becoming more positive. The projections are slightly higher than in the December Report.

OUTPUT GAP

The output gap, also referred to as capacity utilisation, captures resource utilisation in the economy. The output gap is defined as the difference between actual output (GDP) and potential output. Potential output is the highest possible level of output that is consistent with stable price and wage inflation. Over time, potential output growth is determined by trend labour force growth and productivity.

The output gap is a key monetary policy variable. In interest rate setting, weight is given to smoothing fluctuations in output and employment. To achieve this, the aim is to keep the output gap close to zero. This is referred to as normal capacity utilisation.

If we attempt to keep output and employment above that level, wage and price inflation could become too high. The output gap is therefore also an important indicator of future inflation and is related to Norges Bank’s objective of low and stable inflation.

Potential output and the output gap cannot be observed and must be estimated. Norges Bank’s current output gap estimates are the result of an overall assessment of a number of indicators and models. In this assessment, particular weight is given to labour market developments.

Declining population growth

Potential output is projected to grow by about 1.5% annually through the projection period. The projection is based on trend productivity growth of 1% and average trend growth in the labour force of 0.5% for the years 2020–2022.

The projection for trend productivity is based on developments in actual productivity. Early in an upturn, actual productivity normally grows faster than trend. Compared with previous upturns, productivity growth has been low in recent years (Chart 3.21). This indicates that trend productivity growth is also slightly lower than in earlier periods. The projection for growth in trend productivity is in line with average productivity growth over the past decade and unchanged since the December Report.

Trend growth in the labour force is estimated based on demographic projections. Owing to lower labour immigration from Europe in recent years (Chart 3.22), trend growth in the labour force has fallen. An ageing population has also pulled down trend growth owing to a higher number of persons in age groups with lower labour force participation rates. The figures are based on Statistics Norway’s population projections that suggest declining population growth ahead. In the projection, labour immigration picks up slightly, but is considerably lower than at peak around 2010 when much of Europe was in recession.

Capacity utilisation is projected to peak in the first half of 2020 (Chart 1.1b). Mainland GDP growth is expected to be lower than trend growth further ahead and the output gap will be gradually less positive. The projections for capacity utilisation are higher than in December throughout the projection period.

Uncertainty about potential output

Labour force developments are uncertain. The labour force participation rate has decreased over time among young people and men aged between 25 and 54. It is uncertain whether this trend will continue. Labour immigration may also differ from the Bank’s projections. At the same time, there is uncertainty surrounding productivity growth. New technology and increasing digitalisation could boost productivity growth ahead. On the other hand, increased trade barriers and protectionism could push down productivity growth.

3.3 Costs and prices

Underlying inflation has risen

Inflation rose through autumn 2017 and in the period to end-2018 (Chart 3.23). Underlying inflation picked up, partly reflecting higher wage growth. Higher electricity prices also pushed up overall inflation.

Since the December Report, the 12-month rise in the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE) has increased further. In February, 12-month CPI-ATE inflation was 2.6%. Other underlying inflation indicators ranged between 1.8% and 2.9% (see "Indicators of underlying inflation"). The 12-month rise in the consumer price index (CPI) has moderated since the December report, reflecting a slower rise in electricity prices. Although long-term inflation expectations have declined slightly over the past quarter, they are still slightly above 2% (see "Inflation expectations").

Inflation higher than expected

Twelve-month CPI and CPI-ATE inflation was higher in February than projected in the December Report. In the CPI-ATE, prices both for imported goods and for domestically produced goods and services rose more than projected (Chart 3.24).

The 12-month rise in imported and domestic inflation is projected to remain higher in the near term than projected in December (Annex Table 3d). The upward revision of imported inflation reflects a weaker krone than projected in December (see "Financial conditions"). The upward revision of domestic inflation reflects higher-than-expected wage growth. The CPI-ATE projections are closely in line with the SAM-based projections for the coming two quarters (Chart 3.25).

Futures prices for electricity and fuel indicate little change in energy price levels in 2019 (Chart 3.26). Thus, the 12-month rise in the CPI is projected to decline further in the near term. Annual CPI inflation is projected at 2.3% in 2019.

Wage growth picks up

After slowing over several years, wage growth rose in 2017 and 2018. Lower unemployment probably contributed to the rise. Annual wage growth was 2.8% in 2018, in line with the wage settlement norm and slightly higher than projected in the December Report (Chart 3.27). With annual CPI inflation of 2.7%, real wage growth was 0.1% in 2018.

In 2019, wage growth is expected to increase further to 3.3%. The projection is somewhat higher than the social partners’ expectations according to Norges Bank’s expectations survey and higher than expected by Norges Bank’s Regional Network contacts. These surveys tend to slightly underestimate wage growth during upturns. The wage growth projection for 2019 has been revised up since December, reflecting the upward revision of the inflation projection. The projection for real wage growth in 2019 is lower than in the December Report.

Lower-than-expected profitability

Higher capacity utilisation and continued low unemployment are expected to contribute to a further pick-up in wage growth in the next two years. At the same time, the labour income share of mainland GDP is higher than expected (Chart 3.28). A higher labour income share reduces corporate profitability correspondingly and implies in isolation lower wage growth.

Profitability has been lower than anticipated in recent years, despite consistently lower wage growth than projected. So far, the rise in oil prices since 2016 does not appear to have improved profitability in the mainland economy. Weak profitability is particularly pronounced for oil services, reflecting reduced margins in this sector owing to cost reductions by oil companies. This has fuelled a marked rise in the labour income share in oil services (Chart 3.29). The labour income share in other industries fell when the krone exchange rate fell in tandem with oil prices in 2014 and 2015, but remains higher than in the pre-crisis period.

Lower profitability in some business sectors may restrain the rise in wage growth ahead. The wage growth projections are therefore little changed, even though the upturn seems to be more pronounced and oil prices are higher than anticipated in December.

Prospects for inflation close to target

A gradually stronger krone and weaker external price impulses are expected to push down the rise in prices for imported goods ahead. Higher capacity utilisation and increasing wage growth pull in the opposite direction (Chart 3.30). Overall, annual CPI-ATE inflation is projected to be close to 2% in the coming years (Chart 3.31).

The CPI-ATE projections are slightly higher than in the December Report throughout the projection period. This is because the krone is now projected to be slightly weaker and external price impulses to be slightly stronger (Chart 2.8) than assumed in December.

Energy prices in the CPI in the years ahead are expected to move in line with futures prices for electricity and petrol. These futures prices show a decline in the next two years before rising slightly in 2022. The projections for energy prices are somewhat higher than in the December Report.

Overall, the projections for CPI-ATE inflation and energy prices imply a decline in four-quarter CPI inflation in the coming year, followed by a slight rebound further out. At the end of 2022, the projection for four-quarter CPI inflation is 2%. The projections are a little higher than in the December Report throughout the projection period.

With the projections for CPI inflation and annual wage growth, real wage growth rises in 2019 and the next two years, followed by a slight decline in 2022(Chart 1.13). The projections for real wage growth are somewhat lower than in December.

The projections are uncertain

The projections are based on the assumption that lower-than-expected profitability will dampen the rise in wage growth, but it is uncertain to what extent. Lower profitability in some business sectors may pull down wage growth more than projected. At the same time, there is considerable uncertainty associated with future profitability. We have assumed that profitability for mainland enterprises declined in 2018, in line with preliminary QNA figures. Experience shows that these figures are subject to substantial revision. The enterprises in the expectations survey and in Norges Bank’s Regional Network report some strengthening of profitability in recent years. A tighter labour market could also exert greater pressure on wages than expected.

Indicators of underlying inflation

Inflation targeting should be forward-looking and flexible. Norges Bank sets the policy rate with a view to stabilising annual consumer price inflation (CPI) in the medium term. Temporary conditions can lead to substantial short-term fluctuations in CPI inflation. Indicators of underlying inflation can be useful in order to see through such fluctuations.1

The most important indicator of underlying inflation in Norges Bank’s analyses is the CPI adjusted for tax changes and excluding energy products (CPI-ATE). In the past few years, CPI-ATE inflation has been lower than CPI inflation, primarily reflecting high energy price inflation, but also indirect tax increases. Other underlying inflation indicators ranged between 1.8% and 2.9% in February (Chart 3.32). The 12-month average rise in these indicators was 2.4%, up from 1.6% in February 2018.

1 See Husabø, E. (2017) “Indicators of underlying inflation in Norway”. Staff Memo 13/2017, Norges Bank, for a more detailed review of various indicators.

Inflation expectations

Expectations of future inflation have a bearing on many economic decisions, such as price setting and wage formation. Well-anchored inflation expectations can make it easier for monetary policy to achieve the objective of price stability and contribute to smoothing fluctuations in output and employment. Inflation expectations are often referred to as well-anchored when medium- and long-term inflation expectations show little reaction to new information and remain stable and close to target. In recent years, longer-term inflation expectations, as measured in Norges Bank’s expectations survey, have overall remained close to 2.5% (Chart 3.33).1 The inflation target for monetary policy was lowered from 2.5% to 2.0% in March 2018.

The expectations survey for 2019 Q12 showed a slight decline in long-term inflation expectations. In the monetary policy reports published after the revision of the inflation target, it is assumed that it will take some time for inflation expectations to adjust to the new target. This assumption has not been changed in the light of the Q1 survey responses.

1 See Erlandsen, S. K. and P.B. Ulvedal (2017) “Are inflation expectations anchored in Norway?”. Staff Memo 12/2017. Norges Bank, for a more detailed review.

2 The expectations survey was conducted in the period 28 January–15 February 2019.

Financial conditions

The money market premium has declined somewhat

The money market rate Nibor is important for interest rates faced by households and enterprises as interest rates on a large share of banks’ funding are based on Nibor. At the same time, corporate lending rates are often directly linked to Nibor.

Three-month Nibor is determined by the average policy rate expected by the market over the next three months and by a risk premium, which is generally referred to as the money market premium. Since the December Report, the money market premium has declined somewhat, at the same time as three-month policy rate expectations have risen. Overall, three-month Nibor has therefore been fairly stable. The premium, as calculated by Norges Bank, is now just below 0.40 percentage point (Chart 3.34). Looking ahead, the money market premium is expected to remain close to the average of recent months, 0.40 percentage point. The three-month Nibor is projected to rise in tandem with the policy rate ahead.

Somewhat lower market rates

Forward rates have fallen a little since the December Report and indicate a more gradual rate rise than in our projection (Chart 3.35). Fixed rates in the market for interest rate swaps (swap rates) reflect expected average money market rates and influence the fixed interest rates offered to households and firms. In line with lower money market rate expectations further out, swap rates have also fallen somewhat (Chart 3.36).

Gradual rise in lending rates

Following the increase in the policy rate in September, banks’ corporate lending rates have been broadly in line with expectations. Bank and bond interest rates facing enterprises have risen somewhat over the past half-year. Banks in Norges Bank’s lending survey in 2018 Q4 expected a further rise in these rates in 2019 Q1. Risk premiums in the market for high-yield enterprises have risen slightly since December.

The interest rate on housing loans to households rose in 2018 Q4. The interest rate on new loans fell a little between November and December, and was a little lower than envisaged in the previous Report. The margin between the rate on housing loans and Nibor appears to be a little narrower in the near term than anticipated in December (Chart 3.37). It is still assumed that the policy rate hike will affect the interest rate on housing loans with a short lag. The average rate rises from 2.6% currently to around 3.5% in the course of the projection period.

Weaker krone

The krone, as measured by the import-weighted exchange rate index (I-44)-1, has been weaker than projected in December (Chart 3.38). Lower oil prices and heightened uncertainty in financial markets may have contributed to the depreciation of the krone towards the end of 2018. So far in 2019, the krone has appreciated and the depreciation in December has reversed. This may reflect a wider interest rate differential against trading partners and the increase in oil prices.

Prospects for a widening of the interest rate differential against Norway’s trading partners over the next few years point to a stronger krone. The fact that the krone is weaker than implied by a historical relationship between the krone and the interest rate differential and between the krone and oil prices pulls in the same direction. On the other hand, compared with model results, the depreciation has been more pronounced and the krone has remained weaker than envisaged (Chart 3.39). Against this background, the krone is projected to appreciate slightly less than in December (see discussion in "The long-term real exchange rate level"). The krone remains weaker than projected in the December Report through the entire projection period.

A weaker krone than previously assumed will strengthen the cost competitiveness of Norwegian export firms and points towards higher net exports. A weaker krone also pushes up inflation through higher prices for imported goods and services.

There is uncertainty surrounding developments in the krone exchange rate. A rising interest rate level relative to Norway’s trading partners could lead to a stronger appreciation of the krone than envisaged. If global uncertainty recedes, the krone may also appreciate faster than projected. On the other hand, it is also possible that the krone will remain weaker than projected in this Report.

-1 The I-44 index comprises the currencies of 44 of Norway’s trading partners and is calculated as a geometric weighted average. The weight of each currency reflects the share of imports to Norway.

Assumptions concerning fiscal policy

The fiscal policy assumptions in this Report are based on the approved central government budget for 2019 and other available information. Petroleum revenue spending, as measured by the structural non-oil deficit, is estimated at 7.4% of trend mainland GDP in 2019 (Chart 3.40), up 0.2 percentage point from 2018, but 0.1 percentage point below the level in 2017. The estimates are unchanged from the December Report. By comparison, the deficit increased on average by 0.5 percentage point annually between 2012 and 2017.

As in the December Report, the technical assumption is applied that the annual fiscal impulse will be 0.1 percentage point from 2020, ie the structural deficit will increase by 0.1 percentage point annually as a share of trend GDP.

There are prospects that petroleum revenue spending in 2019 will be equivalent to 2.8% of the value of the Government Pension Fund Global (GPFG) at the beginning of the year. Since there has been some increase in value of the GPFG since the beginning of January, the structural deficit may account for a smaller portion of the value of the GPFG through the remainder of the projection period.

Since 2013, public demand has increased by 2%-3% annually (Chart 3.41). In line with the projections in the National Budget 2019, lower growth in public demand is projected for 2019, with growth edging down further in the period ahead. The projections for public demand are unchanged from the December Report.

Projections for petroleum investment

After falling for several years, petroleum investment rose by 3% in 2018 (Chart 3.42). Investment is expected to increase appreciably in 2019. The upswing reflects the substantial cost-cutting measures by oil companies in recent years and the pronounced rise in oil and gas prices since the beginning of 2016. As a result of the cost cuts, break-even prices for new development projects are now USD 10–35 per barrel of oil, which is far lower than the long-term oil prices expected by oil companies. Oil companies have therefore started a number of development projects in new and existing fields since 2016. If oil and gas price developments are approximately as projected in this Report, oil companies are expected to launch a further 20–30 development projects during the projection period (see "Developments in oil and Natural gas prices").

Investment in ongoing development projects increased by NOK 10bn in 2018. Investment is projected to increase by a further NOK 12bn in 2019, falling in the period to 2022 as the development projects are completed. This decrease will to some extent be offset by new development projects scheduled to start ahead (Chart 3.43). However, most of these new projects are small compared with ongoing projects1 as there have been few large discoveries in recent years. Investment in development projects is therefore projected to fall between 2019 and 2022, particularly towards the end of the period. Well and operating investment in fields in production is expected to increase gradually ahead as a result of improved profitability in the petroleum industry in recent years.

Spending on exploration rose by NOK 4bn in 2018, after decreasing by almost half between 2013 and 2017. Exploration investment is projected to increase by a further NOK 4bn in 2019 and then remain stable until 2022. The increase between 2017 and 2019 has largely been driven by lower drilling costs since 2013 and the prospects for oil and gas prices.

Overall petroleum investment is projected to increase by 12.5% in 2019 and by 1% in 2020. Investment is thereafter expected to fall by 1% in 2021 and by 6% in 2022. The investment projections for 2019 and 2020 are somewhat higher than in the December 2018 Report, while the projection for 2021 is a little lower. The projections for 2019 and 2020 have been revised up in the light of the latest investment intentions survey and new information about developments costs for Duva, Grand and Luno 2.2 Other new information could indicate that investment in development projects may be slightly lower after 2020 than expected earlier.

1 Development of the Wisting and Alta-Gohta discoveries may result in investment totalling NOK 80bn-NOK 100bn over five to six years. These developments are expected to commence towards the end of the projection period.

2 The development plan for Duva (previously Cara) was submitted directly after the publication of the first-quarter investment intentions survey. Development of Luno 2 will commence in the near future.

4 Monetary policy analysis

The policy rate has been raised from 0.75% to 1%. In the forecast, the policy rate increases further in the course of the next half-year, reaching 1.75% at the end of 2022.

The policy rate forecast is slightly higher in the next few years, than in the December 2018 Monetary Policy Report and slightly lower further out. The upward revision of the forecast at the start of the projection period partly reflects stronger domestic demand and a weaker krone. The downward revision further out reflects prospects for lower growth and a more gradual rate rise among trading partners.

The projections are uncertain, and uncertainty increases through the projection period. If the outlook or the Bank’s assessment of economic relationships changes, the policy rate forecast will be adjusted.

4.1 Objectives and recent developments

Low and stable inflation

The primary objective of monetary policy is low and stable inflation. From 2001, the operational target of monetary policy was annual consumer price inflation of 2.5%. In March 2018, the target was changed to 2%. Average annual consumer price inflation has been around 2% since 2001 (Chart 4.1).

Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances. Over the past decade, output and employment volatility has been relatively limited despite large shocks to the Norwegian economy (Chart 4.2). A flexible inflation targeting regime has helped to dampen the impact on the real economy. Monetary policy objectives and trade-offs are described further in "Monetary policy objectives and trade-offs".

Continued expansionary monetary policy

The interest rate level in recent years has been historically low, both globally and in Norway. This is because there has been a need for an expansionary monetary policy and because the level of the neutral real interest rate has declined over time. The neutral real interest rate is the rate that is neither expansionary nor contractionary. The neutral real interest rate, measured as the three-month money market rate less inflation, is estimated to lie in the range of 0%-1%.1 The neutral real interest rate cannot be observed and the estimate is highly uncertain.

The money market rate has edged up over the past few years, but the real interest rate remains negative (Chart 4.3). The real interest rate is lower than the Bank’s estimate of the neutral real interest rate.

4.2 New information and assessments

Further rate rise

Monetary policy is expansionary. At the same time, growth in the Norwegian economy is solid. Spare capacity has gradually diminished, and capacity utilisation now appears to be a little above a normal level. Wage growth has risen, and the decline in unemployment suggests a further rise. Underlying inflation is a little higher than the inflation target.

The risk outlook is dominated in particular by global developments. Over the past year, rising protectionism and political uncertainty have weighed on growth. Euro-area growth slowed markedly towards the end of 2018. The UK’s relations with the EU have yet to be clarified. If trade tensions deepen, growth among trading partners may be lower than projected. At the same time, the krone may remain weaker than assumed, if global uncertainty persists. It is also possible that the upturn in Norway will prove to be more pronounced than envisaged. Price and wage inflation may then turn out higher than projected. There is also uncertainty surrounding the effects of monetary policy. Over time, the krone has been weaker than implied by its historical relationship with the oil price and the interest rate differential against other countries. A wider interest rate differential ahead is expected to result in a stronger krone, but the extent of an appreciation is uncertain. Owing to high household debt burdens, an interest rate increase is now likely to dampen household demand to a greater extent than historical experience would indicate. The long period of low interest rates and mounting debt burdens have, however, added to the uncertainty surrounding the effects of higher interest rates.

The outlook for the Norwegian economy suggests that the policy rate should be raised ahead. A rate that is too low over time may increase pressures in the economy, triggering an acceleration in price and wage inflation. Persistently high debt growth has increased household vulnerability. Household debt growth has abated in recent years, but remains higher than growth in disposable income. House prices have risen recently, after showing little change through autumn 2018. Keeping the policy rate low for a long time amplifies the risk of a renewed acceleration in debt growth and house price inflation. High price and wage inflation and a further build-up of financial imbalances increase the risk of a sharp economic downturn further out.

On the other hand, raising the policy rate too rapidly may stifle the upturn, resulting in higher unemployment and below-target inflation. The uncertainty surrounding global developments and the effects of monetary policy suggests a cautious approach to interest rate setting.

Overall, the outlook and the balance of risks imply a gradual rate rise ahead.

Faster rise in capacity utilisation

In analysing the effects of new information and new assessments on the outlook for inflation and the output gap, a model-based exercise is performed where the policy rate forecast from the previous Report is held constant. Norges Bank’s macroeconomic model NEMO2 is used in this exercise, where updated projections for the current and following quarter are applied. Some variables are estimated outside the model for the entire projection period. These include import growth, inflation and interest rates among trading partners, and the oil price, the money market premium, public demand and domestic oil investment. Estimates are shown for the years up to and including 2021, since this was the projection period in the December Report.

The model-based analysis suggests that with a policy rate forecast unchanged since December, CPI-ATE inflation will be a little higher than projected in December throughout the projection period (Chart 4.4a). This reflects, among other factors, a weaker-than-expected krone and the assumption that the conditions contributing to a weak krone are of a more permanent character than envisaged earlier. In isolation, lower-than-expected profitability in some industries pulls down wage inflation in the model-based analysis. Lower wage growth contributes to lower price inflation.

In the projection, capacity utilisation rises a little faster and reaches a higher level than projected in December (Chart 4.4b). This is primarily because GDP growth in the coming period is expected to remain higher than projected earlier, owing in part to an upward revision of the projection for petroleum investment. In addition, a lower real interest rate contributes to higher demand and higher capacity utilisation.

Slightly higher inflation and higher capacity utilisation suggest a slightly faster rate rise than indicated by the policy rate forecast in the December Report.

The policy rate has been raised

The policy rate has been raised from 0.75% to 1%, effective from 22 March 2019. In the forecast, the policy rate increases further in the course of the next half-year, reaching 1.75% at the end of 2022 (Chart 4.5a).

The upturn in the Norwegian economy appears to be stronger than anticipated earlier. On the other hand, there are prospects for weaker growth and lower interest rates abroad. The policy rate forecast indicates a slightly faster rate rise in 2019 and a somewhat lower policy rate further out than in the December Report (Chart 4.6).

In the analysis, the money market rate is assumed to rise in tandem with the rise in the policy rate (Chart 1.8). In the projection, the real interest rate rises in the next few years, and show little change thereafter (Chart 4.7). Compared with the December Report, the real interest rate is projected to be a little lower through most of the projection period.

With the policy rate in line with the forecast, the output gap is projected to be positive throughout the projection period. Capacity utilisation is projected to peak in the first half of 2020, gradually declining thereafter (Chart 4.5b). Compared with the December Report, the projections for capacity utilisation have been revised up somewhat.

Inflation is projected to be at around 2% at the end of 2022 (Charts 4.5c-d). Compared with the December Report, the projections for both the CPI and the CPI-ATE are a little higher.

The projections in this Report are based on Norges Bank’s assessment of the economic situation and the functioning of the economy and the effects of monetary policy. The projections are uncertain and uncertainty increases through the projection period. When the economic outlook changes or if our understanding of the relationship between the interest rate level, inflation and the real economy changes, the policy rate forecast will be adjusted.

Factors behind changes in the policy rate path

The main factors behind the changes in the rate path are illustrated in Chart 4.8. The bars show the various factors’ contributions. The black line shows the overall change in the policy rate forecast. The macroeconomic model NEMO is used as a tool for interpreting the driving forces in the economy, but there is no mechanical relationship between news that deviates from the Bank’s forecasts in the December Report and the effect on the new rate path.

The global growth outlook appears to be somewhat weaker than projected in the December Report. At the same time, forward rates abroad are lower than anticipated in December. Both factors pull down the rate path (green bars).

Oil prices are a little higher than projected in December, resulting in higher oil investment and stronger growth in oil-related exports. On balance, higher oil prices pull up the rate path (beige bars).

Despite higher oil prices and a wider interest rate differential against other countries, the krone has been weaker than projected in December, and the conditions that have contributed to a weak krone are assumed to be of a more permanent character than envisaged earlier (see "The long-term real exchange rate level"). A weaker krone in isolation pulls up the interest rate path (orange bars).

Growth in domestic demand has been higher than projected, with prospects for continued higher-than-projected growth in the first half of 2019, and higher than can be explained by oil price and krone movements. This primarily reflects prospects for higher private investment in 2019, but also for slightly lower lending margins and higher house price inflation than previously assumed. Higher demand suggests a higher interest rate path (dark blue bars).

Inflation has been higher than projected, which in isolation suggests a slightly higher rate path. On the other hand, profitability in some industries has been lower than anticipated, which pulls down on the rise in wage growth and leads to a slower rise in wage growth than implied by the rise in inflation and improved labour market conditions. Lower wage growth pushes down on inflation and pulls in the direction of a lower rate path. On balance, new price and wage data point to a slightly higher policy rate path in the near term and a slightly lower path further out (purple bars).

Since the December Report, new information suggests an upward adjustment of the rate path in the near term, and a slight downward adjustment further out. The uncertainty surrounding global developments and the effects of monetary policy suggests a cautious approach to interest rate setting. That judgement implies a somewhat smaller upward adjustment of the interest rate path than new information in isolation would indicate, as expressed by the light blue bars.

1 See Special Feature “Estimates of the neutral real interest rate” in Monetary Policy Report 2/18 for a detailed discussion.

2 NEMO is described in Kravik, E.M. and Y. Mimir (2019) “Navigating with NEMO”. Staff Memo 5/2019. Norges Bank.

Monetary policy objectives and trade-offs

The operational target of monetary policy is annual consumer price inflation of close to 2% over time. Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances. The various considerations are weighed against each other.

The policy rate is set with a view to stabilising inflation at the target in the medium term. The horizon will depend on the disturbances to which the economy is exposed and the effects on the outlook for inflation and for output and employment.

Monetary policy can contribute to stabilising output and employment at around the highest possible level consistent with price stability over time. This level is determined by structural conditions such as the tax and social security system, the system of wage formation and the composition of the labour force.

When shocks occur, a short-term trade-off may arise between reaching the inflation target and supporting high and stable output and employment. Monetary policy should achieve a reasonable trade-off between these considerations.

A flexible inflation targeting regime, in which sufficient weight is given to the real economy, can prevent downturns from becoming deep and protracted. This can reduce the risk of unemployment becoming entrenched at a high level following an economic downturn.

If there are signs that financial imbalances are building up, the consideration of high and stable output and employment may in some situations suggest keeping the policy rate somewhat higher than would otherwise be the case. To some extent, this can contribute to reducing the risk of sharp economic downturns further ahead. The regulation and supervision of financial institutions are the primary means of addressing shocks to the financial system.

The conduct of monetary policy takes account of uncertainty regarding the functioning of the economy. Uncertainty surrounding the effects of monetary policy normally suggests a cautious approach to interest rate setting. This may reduce the risk that monetary policy will have unintended consequences. The policy rate will normally be changed gradually so that the effects of interest rate changes and other new information about economic developments can be assessed.

In situations where the risk of particularly adverse outcomes is pronounced, or if there is no longer confidence that inflation will remain low and stable, it may in some cases be appropriate to react more strongly in interest rate setting than normal.

The long-term real exchange rate level

The long-term level of the real exchange rate, defined as the ratio of foreign consumer prices to domestic consumer prices measured in a common currency, is an important premise underlying the conduct of monetary policy. The real exchange rate level that is consistent with both internal and external balance over time is often referred to as the equilibrium exchange rate. The equilibrium exchange rate is closely related to a country’s cost competitiveness and reflects structural differences between countries in respect of productivity, terms of trade, preferences and industry structure. These are structural factors that are largely independent of monetary policy. The equilibrium exchange rate is a key variable in our analysis system. It is not an observable variable and must therefore be estimated.

In Norway, the equilibrium exchange rate will likely be influenced by the oil price among other factors. A persistently lower oil price reduces Norway’s petroleum revenues and wealth, which in isolation may require an improvement in competitiveness. It is commonly assumed that a persistent deterioration in the terms of trade normally leads to a weaker equilibrium exchange rate and an adjustment in real wages.1 The adjustment to a new equilibrium exchange rate must occur via a weaker nominal exchange rate or a period of lower domestic price and cost inflation than among trading partners. This strengthens competitiveness, which curbs the negative effects of an oil price decline.

Long-term oil futures prices indicate that a large share of the oil price fall since 2014 is of a more permanent character. Since the oil price fall, the nominal exchange rate has depreciated markedly, and wage growth has been low. A possible interpretation is that the equilibrium exchange rate is weaker. Quantifying the depreciation of the equilibrium exchange rate attributable to the oil price fall is demanding, and associated with considerable uncertainty, particularly in real time. It is therefore natural to adjust the estimates in the light of new economic data. In the model-based analysis, we now apply the assumption that the depreciation of the equilibrium exchange rate after the oil price fall was slightly more pronounced than assumed earlier (Chart 4.9).

In order to illustrate the monetary policy implications of assuming a weaker equilibrium exchange rate, we have used simulations from our macroeconomic model NEMO. Chart 4.10 shows the isolated effects of assuming a 2% weaker equilibrium exchange rate some years back in time. A new retrospective assessment of the equilibrium exchange rate will to some extent also change our perception of the underlying factors that are currently driving economic developments. A weaker equilibrium exchange rate will reduce the extent of the recent krone depreciation attributed to temporary factors. Likewise, the low growth in wages observed in recent years will to a larger extent be a natural part of the adjustment to lower oil prices and will to a lesser extent be attributed to exogenous disturbances. An adjustment to a weaker equilibrium exchange rate in the model results in a weaker nominal exchange rate, which in isolation results in higher inflation and hence a higher interest rate. At the same time, a weaker equilibrium exchange rate occurs in tandem with lower wage growth, which pulls in the opposite direction.

While the nominal exchange rate adjusts fairly quickly, it takes longer for the wage level to reach the new equilibrium. Wage growth may thus remain low for a long period. Overall, a weaker equilibrium exchange rate pushes up inflation in the near term, while lower wage growth pulls down inflation somewhat further out. The shift has little influence on the interest rate outlook in the model.

1 This follows, inter alia, from the Balassa-Samuelson model. Economic theory does not, however, provide an unambiguous answer as to how the terms of trade influence the real exchange rate in the long run. In a model where both labour and capital are input factors the relationship between the equilibrium exchange rate and terms of trade may, for example, depend on the scale properties of the production function.

Part 2: Financial stability

5 Financial stability assessment – decision basis for the countercyclical capital buffer

Financial imbalances have built up over a long period. Household debt is high and is still growing faster than income, although the pace of growth has slowed somewhat. Corporate credit growth remains elevated and is higher than the rate of growth in the economy. Property prices are at historically high levels. House price inflation is now moderate, and following several years of rapidly rising commercial real estate (CRE) prices, the rise in estimated selling prices for prime office space in Oslo has edged down. Bank profitability is solid and losses are low, and banks have ample access to wholesale funding.

Norges Bank’s assessment of financial imbalances has not changed substantially since 2018 Q4. In the period ahead, gradually rising interest rates and moderate house price inflation are expected to dampen household debt growth. There are signs that the rapid rise in CRE prices may continue to slow.

5.1 Global financial stability

With high debt levels in many countries, abrupt increases in interest rates and risk premiums are still among the main risks to global financial stability. Turbulence in international financial markets may lead to shocks to the Norwegian financial system. Global turbulence has had little impact on Norwegian banks since the December 2018 Monetary Policy Report.

High risk-taking in financial markets

Since the December Report, there have been large movements in risk pricing in global financial markets. After rising sharply in December, bond risk premiums have fallen (Chart 5.1). The decline in equity prices that started in autumn 2018 has largely reversed.

In the US, strong economic growth and tax cuts have contributed to solid corporate earnings. At the same time, corporate debt is increasing. Growth in leveraged loans has been strong. These loans are often poorly collateralised, with weak debt protection, but the losses on loans that have been issued recently have so far been low. Growth in such loans was also very high prior to the 2008 financial crisis. Corporate debt as a share of GDP is higher now than at that time.

Global growth prospects have weakened. There is persistent uncertainty surrounding economic and political developments, relating in particular to trade tensions and the UK’s exit from the EU (see Section 2). Nevertheless, with signs of high risk-taking among investors, vulnerabilities may increase, particularly since debt levels are already high.

New EU banking sector measures

The profitability of European banks as a whole is still fairly low and developments in bank share prices have long been weaker than the rest of the market (Chart 5.2). Against the background of a weak real economic outlook for the EU, the European Central Bank (ECB) has announced that it will launch new longer-term refinancing operations for banks (TLTRO-III), with the aim, among other things, of strengthening banks’ funding situation and hence their lending capacity ahead. The loans will be issued on a quarterly basis starting in September 2019 and ending in March 2021, each with a maturity of two years.

European banks continue to reduce their stock of non-performing loans (Chart 5.2), freeing up capital and improving banks’ capacity to extend new loans. The share of non-performing loans was 3.2% in 2018 Q3, a halving since 2014. There are considerable differences between banks, both within and across countries. There has also been a decline in non-performing loans in the US and Japan, albeit from lower levels.

Global financial developments signal low risk in the heatmap at end-2018 Q4 (Chart 5.23). Substantial financial market volatility and a sharp increase in risk premiums towards the end of 2018 indicated reduced risk appetite and therefore signalled a reduction in the build-up of risk, although developments have reversed since end-2018.

5.2 Credit market

In Norway, credit has long risen faster than mainland GDP (see credit indicator in Chart 5.3). This has contributed to the build-up of financial imbalances. Over the past year, the indicator has flattened. The credit gap, which shows the difference between the indicator and an estimated trend, has narrowed for three consecutive quarters, but remained approximately unchanged between 2018 Q3 and 2018 Q4 (Chart 5.4).

Slowing growth in credit to households

Growth in credit to households has slowed in recent years (Chart 5.5). Credit growth is now at its lowest level since 1997, but is still higher than growth in disposable income.

Household debt-to-income ratios are high and have risen substantially over a long period (Chart 5.6). This has contributed to the build-up of financial imbalances. Looking ahead, debt ratios are expected to increase further, but at a somewhat slower pace than projected in the December Report (Chart 3.7). Household debt ratios signal high risk in the heatmap (Chart 5.23).

The interest burden, ie the ratio of interest payments to income, has likely increased following the policy rate rise in September 2018. Nevertheless, from a historical perspective, the interest burden is low (Chart 5.6). Most households have ample capacity to service debt at somewhat higher interest rates. The debt service ratio, ie the ratio of interest and normal principal payments to income, is high and at the same level as during the financial crisis in 2008 and the banking crisis at the beginning of the 1990s (Chart 5.6).

New requirements for banks offering consumer credit1 will be introduced in 2019 and entail a tightening of lending standards. Since consumer debt accounts for approximately 3% of total household debt, the new requirements will likely have little impact on growth in total household debt. Nevertheless, the regulation may restrain the build-up of household sector vulnerabilities (see Financial Stability Report 2018).

The banks included in Norges Bank’s lending survey still expect unchanged residential mortgage demand and unchanged credit standards for households.

In the period ahead, household credit growth is expected to remain at approximately today’s level (Annex Table 4).

Sustained corporate credit growth

Enterprises have ample access to credit. Growth in corporate credit from domestic sources increased through 2017 and has been between 6% and 7% in recent months (Chart 5.5). Developments in corporate debt signal low risk in the heatmap (Chart 5.23).

Banks and mortgage companies are the main contributors to growth in domestic credit, and growth in credit from these funding sources is broad-based across industries (Chart 5.7). CRE loans, which account for over 40% of banks’ and mortgage companies’ overall lending, has provided the largest contribution to growth for a long period.

Growth in bond and short-term paper debt declined through 2018 (Chart 5.8). Corporate bond redemptions are higher in 2019 than in 2018, which may boost issue activity ahead. There was a marked rise in risk premiums towards the end of 2018. Risk premiums in the low-yield segment have since stabilised and are now somewhat lower than in December 2018, while premiums in the high-yield segment have risen by approximately 25 basis points.

According to Norges Bank’s lending survey for 2018 Q4, banks expect unchanged credit demand from non-financial enterprises and credit standards for enterprises. Banks reported somewhat higher funding costs for lending to non-financial enterprises, in line with the increase in the policy rate in September. For 2019 Q1, banks expect both lending rates and funding costs to increase further. In the period ahead, credit growth for non-financial enterprises is assumed to remain at approximately the current level.

Estimated credit risk linked to total bank debt of non-financial enterprises is low, but is expected to increase somewhat in 2019 and 2020 in most industries (Chart 5.9). Commercial real estate accounts for the largest contribution to growth in total credit risk owing to banks’ high exposure to the sector. All corporate indicators signal low risk in the heatmap (Chart 5.23).

5.3 Housing market

House prices have risen sharply over a long period. Since 2017 Q1, house prices have risen somewhat less than disposable income (Chart 5.10). In the heatmap, housing market developments have signalled low risk since 2017 Q4 (Chart 5.23). At the same time, the high level of house prices entails vulnerability for the Norwegian financial system (see Financial Stability Report 2018).

House price inflation has been particularly high relative to per capita disposable income (Chart 5.10), which may reflect reduced housing affordability. However, analyses conducted by Norges Bank show that for large groups of households in Norway, housing affordability, measured as the share of homes sold that a household is able to debt-finance based on its income, remains virtually unchanged (see "Housing affordability"). This is consistent with the impression provided by earlier model-based analyses, based on variables including unemployment, income growth and interest rates, which find that house prices are in line with that implied by historical relationships.2 The results may indicate that the risk of a fall in housing demand, and hence of a fall in house prices, may be lower than implied by the ratio of average house prices to disposable income per capita.

Moderate house price inflation

House prices have risen slightly more than expected in recent months, after having shown little change through autumn 2018. The 12-month rise was 3.0% in February. In Oslo, the seasonally-adjusted rise in prices in recent months has been more stable than in the other large Norwegian cities (Chart 5.11). The 12-month rise is still highest in the capital, but regional differences have narrowed.

Activity in the market for existing homes has recently been high. A large number of dwellings are listed for sale, but turnover remains elevated. The number of unsold homes is declining, but still high. The unadjusted stock of unsold homes has been at its highest monthly level since the financial crisis each month since June 2018 (Chart 5.12). In the market for new homes, few homes have been listed for sale, while turnover has remained stable.

There is uncertainty regarding future house prices. Residential construction is at a high level and the number of building permits issued for housing starts has increased over the past half-year. In the Bank’s projection, the number of housing starts will level off at a high level and many homes will be completed in 2019 (Chart 5.13). As many of the buyers of new homes are likely to sell their existing homes, the number of existing homes listed for sale is expected to remain elevated ahead. This may have a dampening effect on house price inflation. For a long period, residential construction has been outpaced by household formation in the main urban areas. This backlog in residential construction reduces the likelihood that the high completion rate will cause a substantial fall in house prices.3 Household debt ratios are high, which adds to the uncertainty concerning the effects of increased interest rates on house prices. In the coming years, house prices are expected to rise by between 2% and 4% (Annex Table 4). See Section 3.1 for a further discussion of the projections for house price inflation.

5.4 Commercial real estate market

There has been a marked rise in CRE prices over a long period. Prices are at historically high levels, which has contributed to the build-up of financial imbalances. Experience shows that CRE prices have risen sharply ahead of financial crises. The high level also implies a risk. Developments in CRE prices are important for banks owing to their substantial CRE exposures. The CRE market indicator signals high risk in the heatmap (Chart 5.23).

Slowing commercial property price inflation

Estimated selling prices for prime real estate have risen sharply in recent years, but the rate of increase abated between 2018 Q3 and 2018 Q4 (Chart 5.14). Selling prices are estimated as the ratio of market rents to yields4. Rents rose markedly in Oslo in 2017 and 2018 (Chart 5.15). Market participants cited low construction activity, conversions of existing buildings to other uses and increased demand as contributory factors. According to the real estate company Entra’s 2018 Q4 Consensus Report, a fairly sharp rise in rents in central Oslo is also expected in 2019, while the rise in other areas in Oslo is expected to be more moderate.

Yields on prime real estate in Oslo fell over several years, but held steady through 2018. Yields have also declined in other office segments in Oslo (Chart 5.16). Other large Norwegian cities experienced similar developments. Financing costs have risen in pace with the rise in long-term interest rates (Chart 5.16) and market participants expect that yields on office space in Oslo will rise somewhat in the coming years.5 This suggests that the rise in prices may slow further ahead.

5.5 Banks

Stricter capital and liquidity requirements following the financial crisis have strengthened the resilience of banks against losses and market stress. New deposit guarantee rules and bank recovery and resolution rules entered into force in Norway on 1 January 2019,6 aimed at further strengthening the framework for managing troubled banks. A majority of the banking indicators in the heatmap signals low risk, but a larger share of real estate lending and increased exposure to other Norwegian financial institutions in recent years have, in isolation, increased banks’ risk related to concentration and interconnectedness (Chart 5.23).

Banks are profitable and meet capital requirements

Norwegian banks’ profitability is solid, even though large Norwegian banks’ return on equity has declined somewhat over the past quarter (Chart 5.17). An increase in net interest income is making a positive contribution to earnings. In response to the policy rate hike in September, banks raised interest rates on existing loans, with effect from November (see "Financial conditions"). Along with increased operating costs, other income items pulled profitability down somewhat (Chart 5.18).

Low losses are making a positive contribution to profitability. The low losses reflect solid developments in the Norwegian economy, but developments in parts of oil-related industries may still pose a risk of losses for banks. Debt-servicing capacity fell further for drilling and supply in 2018 (Chart 5.19), and many of the enterprises have recognised new impairment losses on vessels.7

Banks are well positioned to comply with changes to capital requirements, including the December 2018 decision to increase the countercyclical capital buffer to 2.5% from end-2019. Banks’ capital ratios are broadly in line with regulatory requirements and banks’ long-term Common Equity Tier 1 (CET1) targets (Chart 5.20). The forthcoming transposition of EU regulations into Norwegian law will reduce the capital required to achieve the same risk-weighted capital ratio. Regulatory changes are expected for systemically important financial institutions, which will likely increase capital requirements for certain large savings banks.8

Norwegian banks’ lending capacity is solid

Norwegian banks’ market capitalisation fell considerably during the stock market decline in 2018 Q4, but has since recovered (Chart 5.21). Banks have ample access to wholesale funding, in both NOK and foreign currency. The risk premiums Norwegian banks pay over three-month Nibor for senior bonds and covered bonds have fallen somewhat since the December Report. In the liquidity survey, banks reported somewhat improved access to funding.

Banks will likely have sufficient capacity to meet credit demand. Twelve-month growth in bank lending to Norwegian enterprises increased in 2017, stabilising at just over 6% in 2018 (Chart 5.22). Relative to lending from branches of foreign banks in Norway, Norwegian banks’ share of corporate lending growth has increased in 2018. According to banks’ quarterly reports for 2018 Q4, total lending growth ahead is expected to range between 5% and 6%.

1 See “Forskrift om krav til finansforetakenes utlånspraksis for forbrukslån” [Regulation on requirements for financial institutions’ consumer credit standards] (In Norwegian only).

2 See box on page 42 in Monetary Policy Report 4/17.

3 See Mæhlum, S., P. M. Pettersen and H. Xu (2018) “Residential construction and household formation”. Staff Memo 12/2018. Norges Bank, for a further discussion.

4 Yields depend on a number of different factors, including the risk-free rate, the risk premium and expected future rents.

5 See Entra’s Consensus Report for February 2019 and DNB Næringsmegling.

6 See Act on the Norwegian Banks’ Guarantee Fund and Act to amend the Financial Institutions Act (deposit guarantee and bank recovery and resolution) (in Norwegian only).

7 See Hjelseth, I.N., L.-T. Turtveit and H. Winje (2016) “Banks’ credit risk associated with the oil service industry”. Economic Commentaries 5/2016. Norges Bank, for a further discussion of the different segments of the oil service industry and of the sample of the companies included in this analysis.

8 See the Ministry of Finance’s website (in Norwegian only) for more information.

A heatmap for monitoring systemic risk

Norges Bank’s ribbon heatmap is a tool for assessing systemic risk in the Norwegian financial system. The heatmap tracks developments in a broad range of indicators for three main areas: risk appetite and asset valuations, non-financial sector vulnerabilities (household and corporate) and financial sector vulnerabilities.1

Developments in each individual indicator are mapped into a common colour coding scheme, where green (red) reflects low (high) levels of vulnerability. The heatmap thus provides a visual summary of current vulnerabilities in the Norwegian financial system compared with historical episodes. The composite indicators are constructed by averaging individual indicators.

Chart 5.23 Composite Indicators in the heatmap 1980 Q1 – 2018 Q42

1 See Arbatli, E.C. and R.M. Johansen (2017) “A Heatmap for Monitoring Systemic Risk in Norway”, Staff Memo 10/2017. Norges Bank, for a detailed description of the heatmap and the individual indicators. See also box on √4 of Monetary Policy Report 4/17.

2 The equity market indicator is revised in order to only reflect developments in equity prices relative to trend. This indicator has previously also reflected developments in the price/earnings ratio (PE ratio).

An improved composite indicator of systemic stress (CISS) for Norway

Norges Bank’s advice on the countercyclical capital buffer is based on a broad set of qualitative and quantitative information. The European Systemic Risk Board (ESRB) emphasises that developments in a general indicator for systemic stress in the financial system should be a part of this decision basis.1

The composite indicator of systemic stress (CISS), introduced by Holló (2012), provides an overall measure of the stress level in the financial system.2 It has proved to be a good indicator for signaling systemic banking crises in real time or in the near future.3 The indicator is based on five submarkets that comprise the core of the financial system: The money, bond, equity, banking, and commodity and foreign exchange markets. In constructing the indicator, consideration is given to the greater challenge to the financial system posed by simultaneous stresses in these market segments than periods without such correlation. Norges Bank has revised the CISS for Norway, which is now more comparable with other countries’ stress indicators.4

The revised version of CISS has reached high levels during crises (Chart 5.24). The chart shows developments in stress levels for the five submarkets comprising the indicator (above zero), and the correlation between the market segments (below zero). The indicator reached its highest point so far during the financial crisis in the autumn of 2008. The level of stress was then high in all five of the submarkets simultaneously. During the euro area sovereign debt crisis, the CISS also increased markedly, but was considerably lower than during the financial crisis. This reflects the lower stress level in each of the submarkets at the time and the relatively weaker correlation.

Historically, the Norwegian version of CISS has largely been correlated with euro area countries (Chart 5.25). This reflects the normally rapid spread of global financial turbulence to small, open economies like Norway. See Hagen and Pettersen (2019) for a more detailed review of CISS for Norway.5

1 See European Systemic Risk Board (2014), “Recommendation of the European Systemic Risk Board of 18 June 2014 on guidance for setting countercyclical buffer rates”.

2 See Holló, D., M. Kremer, and M. L. Duca. (2012), “CISS – A composite indicator of systemic stress in the ﬁnancial system”. Working Paper Series No 1426. European Central Bank.

3 See Deiken, C. et al (2014), “Operationalising the countercyclical capital buffer: indicator selection, threshold identification and calibration options”. ESRB Paper Series 05.

4 In 2015, a CISS was constructed for Norway (see Wen, Y. (2015), “A composite indicator of systemic stress (CISS) for Norway”. The revised indicator is based on the indicator presented by Wen (2015), but more closely follows the framework presented by Holló et al (2012), like the CISS used by the ECB and several other European central banks.

5 Hagen, M. and P. M. Pettersen (2019) “En revidert sammensatt systemisk stressindikator (CISS) for Norge” [An improved composite indicator of systemic stress (CISS) for Norway]. (Forthcoming in English) Staff Memo 3/19. Norges Bank.

Annex

Monetary policy meetings in Norges Bank

Date1

Policy rate2

Change

19 June 2019

8 May 2019

20 March 2019

1.00

0.25

23 January 2019

0.75

0

12 December 2018

0.75

0

24 October 2018

0.75

0

19 September 2018

0.75

0.25

15 August 2018

0.50

0

20 June 2018

0.50

0

2 May 2018

0.50

0

14 March 2018

0.50

0

24 January 2018

0.50

0

13 December 2017

0.50

0

25 October 2017

0.50

0

20 September 2017

0.50

0

21 June 2017

0.50

0

3 May 2017

0.50

0

14 March 2017

0.50

0

14 December 2016

0.50

0

26 October 2016

0.50

0

21 September 2016

0.50

0

22 June 2016

0.50

0

11 May 2016

0.50

0

16 March 2016

0.50

-0.25

16 December 2015

0.75

0

4 November 2015

0.75

0

23 September 2015

0.75

-0.25

17 June 2015

1.00

-0.25

6 May 2015

1.25

0

18 March 2015

1.25

0

10 December 2014

1.25

-0.25

22 October 2014

1.50

0

17 September 2014

1.50

0

18 June 2014

1.50

0

7 May 2014

1.50

0

26 March 2014

1.50

0

4 December 2013

1.50

0

23 October 2013

1.50

0

18 September 2013

1.50

0

1 The interest rate decision has been published on the day following the monetary policy meeting as from the monetary policy meeting on 13 March 2013. The interest rate decision at the monetary policy meeting on 14 March 2017 was published two days after the meeting.

2 The policy rate is the interest rate on banks’ sight deposits in Norges Bank. This interest rate forms a floor for money market rates. By managing banks’ access to liquidity, Norges Bank ensures that short-term money market rates are normally slightly higher than the policy rate.

Table 1 Projections for GDP growth in other countries

Change from projections in Monetary Policy Report 4/18 in brackets

Share of world GDP1

Trading partners4

Percentage change from previous year

PPP

Market exchange rates

2018

2019

2020

2021

2022

US

16

25

9

2.9 (0)

2.2 (-0.2)

1.8 (0)

1.7 (-0.1)

1.7

Euro area

12

16

33

1.8 (-0.1)

1.1 (-0.5)

1.4 (-0.1)

1.5 (0)

1.5

UK

2

4

10

1.4 (0.1)

1.1 (-0.3)

1.4 (-0.1)

1.5 (0)

1.5

Sweden

0.4

0.7

12

2.4 (0)

1.6 (-0.2)

1.7 (-0.2)

1.8 (-0.1)

2.0

Other advanced economies2

7

10

18

1.9 (0)

1.7 (-0.2)

1.7 (-0.1)

1.9 (0)

1.9

China

16

15

6

6.6 (0.1)

6 (0)

5.8 (0)

5.8 (0)

5.8

Other emerging economies3

19

11

12

3.6 (-0.1)

3.3 (-0.3)

3.8 (-0.1)

3.9 (-0.1)

4.0

Trading partners4

72

79

100

2.6 (0)

1.9 (-0.3)

2.1 (0)

2.1 (0)

2.2

World (PPP)5

100

3.6 (-0.1)

3.2 (-0.3)

3.5 (-0.1)

3.6 (0)

3.7

World (market exchange rates)5

100

3.1 (0)

2.6 (-0.4)

2.8 (0)

2.9 (0)

2.9

1 Country’s share of global output measured in a common currency. Average 2015–2017.

2 Other advanced economies in the trading partner aggregate: Denmark, Japan, Korea, Singapore and Switzerland. Export weights.

3 Emerging economies in the trading partner aggregate excluding China: Brazil, India, Indonesia, Poland, Russia, Thailand and Turkey. GDP weights (market exchange rates) are used to reflect the countries’ contribution to global growth.

4 Export weights, 25 main trading partners.

5 GDP weights, three-year moving average.

Sources: IMF, Thomson Reuters and Norges Bank

Table 2 Projections for consumer prices in other countries

Change from projections in Monetary Policy Report 4/18 in brackets

Trading partners4

Percentage change from previous year

2018

2019

2020

2021

2022

US

8

2.4 (-0.1)

1.8 (-0.5)

2.3 (-0.1)

2.3 (0)

2.3

Euro area

33

1.8 (0)

1.2 (-0.3)

1.5 (-0.1)

1.6 (-0.1)

1.7

UK

6

2.3 (0)

1.9 (-0.1)

2.1 (0)

2 (0)

1.9

Sweden1

13

2.1 (-0.1)

1.9 (0)

2 (0)

2 (0)

2.0

Other advanced economies2

17

1.1 (-0.2)

1.4 (-0.1)

1.6 (-0.1)

1.7 (0)

1.6

China

12

2.1 (-0.2)

2.2 (-0.2)

2.4 (-0.3)

2.7 (0)

2.6

Other emerging economies3

10

4.7 (-0.1)

5.2 (-0.3)

4.8 (0.4)

4.5 (0.1)

4.3

Trading partners4

100

2.1 (-0.1)

2 (-0.2)

2.1 (-0.1)

2.2 (0)

2.1

Underlying inflation5

1.4 (0)

1.5 (-0.3)

1.7 (-0.2)

1.9 (0)

1.9

Wage growth6

2.7 (0)

2.6 (0)

2.9 (-0.1)

2.9 (-0.2)

2.9

1 Consumer price index with a fixed interest rate (CPIF).

2 Other advanced economies in the trading partner aggregate: Denmark, Japan, Korea, Singapore and Switzerland. Import weights.

3 Emerging economies in the trading partner aggregate excluding China: Brazil, India, Indonesia, Poland, Russia, Thailand and Turkey. GDP weights (market exchange rates).

4 Import weights, 25 main trading partners.

5 The aggregate for underlying inflation includes: the euro area, Sweden, UK and US. Import weights.

6 Projections for compensation per employee in the total economy. The aggregate includes: the euro area, Sweden, UK and US. Export weights.

Sources: IMF, Thomson Reuters and Norges Bank

Table 3a GDP for mainland Norway. Quarterly change. Seasonally adjusted. Percent

2018

2019

Q3

Q4

Q1

Q2

Actual

0.4

0.9

Projections in PPR 4/18

0.7

0.7

Projections in PPR 1/19

0.6

0.8

Sources: Statistics Norway and Norges Bank

Table 3b Registered unemployment (rate). Percent of labour force. Seasonally adjusted

2018

2019

Dec

Jan

Feb

Mar

Apr

May

Jun

Actual

2.4

2.4

2.3

Projections in PPR 4/18

2.4

2.4

2.4

2.4

Projections in PPR 1/19

2.3

2.3

2.3

2.3

Sources: Norwegian Labour and Welfare Administration (NAV) and Norges Bank

Table 3c LFS unemployment (rate).1 Percent of labour force. Seasonally adjusted

2018

2019

Oct

Nov

Dec

Jan

Feb

Mar

Apr

Actual

4.0

3.8

3.7

Projections in PPR 4/18

4.0

4.0

4.0

3.9

Projections in PPR 1/19

3.6

3.6

3.6

3.6

1 Labour Force Survey.

Sources: Statistics Norway and Norges Bank

Table 3d Consumer prices. Twelve-month change. Percent

2018

2019

Dec

Jan

Feb

Mar

Apr

May

Jun

Consumer price index (CPI)

Actual

3.5

3.1

3.0

Projections in PPR 4/18

3.1

2.8

2.3

2.4

Projections in PPR 1/19

2.9

2.5

2.6

2.2

CPI-ATE1

Actual

2.1

2.1

2.6

Projections in PPR 4/18

1.9

2.2

2.0

2.2

Projections in PPR 1/19

2.6

2.3

2.5

2.4

Imported consumer goods in the CPI-ATE

Actual

1.4

0.9

2.3

Projections in PPR 4/18

1.2

1.7

1.8

1.6

Projections in PPR 1/19

2.2

1.7

1.8

1.8

Domestically produced goods and services in the CPI-ATE2

Actual

2.4

2.8

2.7

Projections in PPR 4/18

2.3

2.5

2.2

2.7

Projections in PPR 1/19

2.8

2.6

2.9

2.8

1 CPI adjusted for tax changes and excluding energy products.

2 The aggregate ”domestically produced goods and services in the CPI-ATE” is calculated by Norges Bank.

Sources: Statistics Norway and Norges Bank

Table 4 Projections for main economic aggregates

Change from projections in Monetary Policy Report 4/18 in brackets

In billions of NOK 2018

Percentage change from previous year (unless otherwise stated)

2018

Projections

2019

2020

2021

2022

Prices and wages

Consumer price index (CPI)

2.7 (0)

2.3 (0.5)

1.7 (0.1)

1.8 (0.1)

2.0

CPI-ATE1

1.6 (0.1)

2.3 (0.3)

2.0 (0.1)

1.9 (0)

2.0

Annual wages

2.8 (0.1)

3.3 (0.1)

3.5 (0)

3.7 (-0.1)

3.6

Real economy2

Gross domestic product (GDP)

3537

1.7 (0)

2.4 (0.4)

2.0 (0.2)

1.7 (-0.2)

1.5

GDP, mainland Norway

2908

2.5 (0.1)

2.7 (0.4)

1.8 (0.2)

1.2 (-0.2)

1.1

Output gap, mainland Norway (level)3

-0.2 (0.1)

0.6 (0.2)

0.8 (0.3)

0.5 (0.1)

0.2

Employment, persons, QNA

1.6 (0.1)

1.4 (0.3)

0.8 (0.1)

0.3 (0)

0.1

Labour force, LFS4

1.5 (0)

1.3 (0.1)

0.7 (0.1)

0.4 (0)

0.2

LFS unemployment (rate, level)

3.8 (-0.1)

3.6 (-0.2)

3.5 (-0.3)

3.6 (-0.2)

3.6

Registered unemployment (rate, level)

2.4 (0)

2.3 (-0.1)

2.2 (-0.1)

2.3 (0)

2.4

Demand2

Mainland demand5

3063

1.6 (0.2)

1.8 (0.1)

1.9 (0.1)

1.7 (0.1)

1.9

- Household consumption6

1539

2.1 (0.2)

1.9 (0)

2.4 (0.1)

2.3 (0.1)

2.5

- Business investment

309

1.8 (0.8)

4.1 (0.4)

2.5 (1.3)

1.0 (0.7)

1.8

- Housing investment

192

-6.0 (3.7)

0.0 (1.4)

1.2 (-0.4)

1.3 (-0.4)

1.5

- Public demand7

1023

2.4 (-0.5)

1.4 (0)

1.2 (0)

1.1 (0)

1.1

Petroleum investment8

154

3.3 (1.2)

12.5 (2.0)

1.0 (-2.0)

-1.0 (-1.5)

-6.0

Mainland exports9

651

2.5 (-1.0)

4.5 (-0.2)

2.7 (-0.4)

2.2 (-0.8)

2.6

Imports

1154

0.9 (-0.8)

2.7 (-0.4)

3.3 (0.3)

3.3 (0.1)

3.1

House prices and debt

House prices

0.7 (0)

2.4 (0.8)

3.0 (-0.1)

3.2 (0.4)

3.6

Credit to households (C2)10

5.5 (-0.2)

5.4 (-0.4)

5.2 (-0.3)

5.4 (0.2)

5.7

Interest rate and exchange rate (level)

Policy rate11

0.6 (0)

1.1 (0.1)

1.6 (0.2)

1.7 (-0.1)

1.7

Import-weighted exchange rate (I-44)12

104.6 (0.1)

104.4 (1.0)

102.0 (0.4)

101.6 (1.3)

101.6

Money market rates, trading partners13

0.4 (0)

0.6 (-0.1)

0.6 (-0.2)

0.7 (-0.3)

0.9

Oil price

Oil price, Brent Blend. USD per barrel14

71 (0)

66 (4)

65 (3)

63 (2)

62

1 CPI adjusted for tax changes and excluding energy products.

2 All figures are working day-adjusted.

3 The output gap measures the percentage deviation between mainland GDP and projected potential mainland GDP.

4 Labour Force Survey.

5 Household consumption and private mainland gross fixed investment and public demand.

6 Includes consumption for non-profit organisations.

7 General government gross fixed investment and consumption.

8 Extraction and pipeline transport.

9 Traditional goods, travel, petroleum services and exports of other services from mainland Norway.

10 Credit growth is calculated as the four-quarter change at year-end.

11 The policy rate is the interest rate on banks’ deposits in Norges Bank.

12 The weights are estimated on the basis of imports from 44 countries, which comprise 97% of total imports. A higher value denotes a weaker krone exchange rate.

13 Based on three-month money market rates and interest rate swaps.

14 Spot price 2018. The price for 2019 is calculated as the average spot price so far in 2019 and futures prices for the remainder of the year. Futures prices for 2020–2022. Futures prices at 15 March 2019.

Sources: Eiendomsverdi, Finn.no, Norwegian Labour and Welfare Administration (NAV), Real Estate Norway, Statistics Norway, Thomson Reuters and Norges Bank