The Executive Board's monetary policy decision – background and general assessment
Meeting 29 October 2008
The Executive Board placed emphasis on the following new information that has emerged since the previous monetary policy meeting on 15 October:
- After the authorities in several countries announced a range of measures to address the financial crisis on 13 October, fears of a systemic failure in the banking sector eased. The authorities in many European countries have put forward proposals for injecting fresh equity capital and for the full or partial acquisition of several large financial institutions. Nevertheless, access to credit is limited and risk premiums in money markets are high.
- The IMF has concluded tentative lending agreements with Iceland, Ukraine and Hungary. Discussions are also being held with several countries about possible funding needs, and guidance in addressing the crisis is being provided to authorities in various countries.
- According to the Federal Reserve, short-term funding has been under considerable strain in recent weeks as money market mutual funds and other investors have had difficulty selling assets to satisfy redemption requests. With the aim of improving liquidity, the Federal Reserve has established a new lending facility for money market funds, under which the Fed will provide funding for purchases of certificates of deposit and commercial paper directly from money market funds.
- The central banks in New Zealand, Sweden and Canada have lowered their official policy rates by 1.00, 0.50 and 0.25 percentage point, respectively. Denmark’s Nationalbank has raised its official policy rate by 0.50 percentage point. Market participants expect central bank key rates to be reduced further among most of our trading partners.
- Premiums in the money market in the US and the euro area have edged down. In the US, the premium on three-month money market rates has been 2.6 percentage points on average over the past five trading days, while it has been 1.7 percentage points in the euro area. In the UK, the premium on three-month money market rates has remained virtually unchanged at 2.2 percentage points since the previous monetary policy meeting.
- In Norway, money market rates have moved down somewhat for most maturities. Over the past five trading days, the three-month NIBOR has on average been 6.7 per cent. The premiums on most money market rates have edged down. The premium on three-month money market rates has increased, however, and has been about 2.1 percentage points over the past five trading days.
- The Storting (Norwegian parliament) has authorised the Ministry of Finance to introduce an arrangement for the exchange of government securities for Norwegian covered bonds (OMFs) in amounts up to a total of NOK 350 billion. Banks can conclude swap agreements for a period of up to three years. Covered bonds accepted as collateral by the government will temporarily be exchanged for Treasury bills.
- Norges Bank has auctioned a six-month F-loan and has supplied US dollar liquidity to banks under Norway’s jurisdiction against collateral in securities already eligible under Norges Bank’s lending facilities. Norwegian krone liquidity has also been swapped for euros with banks active in the Norwegian money market.
- The Ministry of Finance has introduced new, temporary accounting rules for recording financial instruments. The rules provide some scope for deviating from the rule requiring the immediate write-down of financial instruments to market value.
- Norwegian banks’ weighted lending rate on new highly secured home mortgage loans has fallen by about 0.4 percentage point to almost 7.4 per cent. Several banks in the Norwegian market have reduced their deposit and lending rates or cancelled previously announced increases.
- According to Norges Bank’s Survey of Bank Lending, a far larger share of banks tightened their credit standards for households in the third quarter than in the second quarter of this year. The survey also showed that banks continued to tighten credit standards for non-financial corporations. Tightening for loans to the commercial real estate sector was considerable. Banks expect a further tightening of credit standards for household and corporate loans in the fourth quarter.
- Equity prices have continued to fall. The Oslo Stock Exchange benchmark index has fallen by about 55 per cent since the peak in May.
- Oil prices have continued to fall. The spot price of Brent blend oil has averaged USD 62 per barrel in the past five trading days. The average futures price for delivery in 2009 has been around USD 71 per barrel in the past five trading days.
- The Economist commodity price index has fallen by 8 per cent measured in XDR (1). By the same measure, food prices have fallen by 4 per cent and the price of fresh salmon by 3 per cent, while the price of frozen salmon has fallen by 1 per cent. Industrial metals prices have fallen by 16 per cent measured in XDR, and the price of aluminium has fallen by 10 per cent. Dry cargo freight rates have fallen by 33 per cent in XDR terms.
- Fluctuations in exchange rates are unusually wide, and the krone has depreciated substantially. In the past five trading days, the import-weighted krone exchange rate has averaged 99.7, which is 4.1 per cent weaker than at the time of the previous monetary policy meeting. Since the end of September, the krone has depreciated by 7.9 per cent.
- According to External Trade Statistics, import prices for goods excluding ships and oil platforms rose by 2.2 per cent from the second to the third quarter this year, measured in NOK. Import prices for consumer goods excluding cars rose by 2.5 per cent.
- The volume of traditional exports increased by a seasonally adjusted 1.7 per cent from the second to the third quarter of 2008. By the same measure, the volume of imports excluding ships and oil platforms rose by 4.3 per cent. Both imports excluding ships and oil platforms and traditional exports have increased by 6.0 per cent so far this year compared with the first three quarters of 2007.
- Statistics Norway’s business tendency survey for manufacturing showed a marked decline in the third quarter in the composite economic indicator for manufacturing. The indicator fell to its lowest level since the first quarter of 2003. Total manufacturing production slowed in volume terms and there was a decrease in new orders from both domestic and export markets.
- In line with other house price statistics, Statistics Norway's quarterly house price index now shows a decline in house prices. The four-quarter rise was a negative 2.4 per cent in the third quarter of this year, down from 0.6 per cent in the second quarter. According to the consulting firm ECON Pöyry, there was a marked increase in the number of completed dwellings for sale in South eastern Norway in October this year compared with October last year.
The effects of the financial crisis will most likely be more pronounced than envisaged only recently. The financial market turmoil has affected household and business confidence in the future and worsened investment and consumption prospects in many parts of the world. Equity prices have declined sharply since June, and oil and commodity prices have fallen. The slowdown in the Norwegian economy appears to be occurring rapidly and is likely to be pronounced.
On the other hand, the krone has depreciated substantially. Low risk willingness has prompted investors to reduce their exposure to less liquid currencies such as the Norwegian krone. The fall in the price of oil and other commodities has probably also contributed somewhat to the depreciation. The krone exchange rate is expected to appreciate gradually when financial market conditions improve.
A weaker krone may still contribute to underpinning output and employment in internationally exposed sectors and help counter the effects of the fall in commodity prices. At the same time, petroleum investment is at a high level and government spending growth is high.
Inflation remains high. Inflation has picked up markedly since autumn 2007, but the forces that have fuelled inflation have now diminished. Should the krone remain weak for a long period, inflation may remain high. This may affect inflation expectations and influence interest rate setting. Norges Bank will therefore closely monitor developments in the krone exchange rate ahead. Expectations of low and stable inflation in Norway are decisive for stability in the economy and the effectiveness of monetary policy measures.
When setting the key policy rate, we must also take account of developments in premiums in money market rates, other bank funding costs and bank deposit and lending rates. Premiums in money market rates are still high and volatile. Comprehensive measures taken by the Norwegian government and Norges Bank have led to some decline in premiums in the past two weeks. At the same time, several banks have reduced their deposit and lending rates or cancelled previously announced increases. Weight is given to moving forward the reduction in the key policy rate so that lending rates for households and firms can gradually be reduced.
There is now unusually high uncertainty surrounding economic developments ahead. It is difficult to provide an indication of the likelihood of different outcomes. In such decision-making situations, it may be appropriate to implement measures that can reduce the uncertainty and stave off a particularly adverse outcome for the economy. This now implies a more active monetary policy than normal, both in interest rate setting and through liquidity policy measures.
The analysis in Monetary Policy Report 3/08 suggests a fairly rapid reduction in the key policy rate to a lower level than projected in the previous Report. The Executive Board’s strategy is that the key policy rate should be in the interval 4% – 5% in the period to the publication of the next Report on 25 March 2009, unless the Norwegian economy is exposed to new major shocks.
The Norwegian authorities have implemented a broad range of measures to address the situation in money and credit markets. Changes in Norges Bank’s key policy rate will not in isolation improve the flow of credit in the financial sector. The key policy rate is set with a view to stabilising developments in inflation, output and employment. An overall assessment of the outlook and the balance of risks suggests that it is appropriate to reduce the key policy rate by 0.50 percentage point at this meeting. As an alternative, the Executive Board considered reducing the key policy rate by 0.25 percentage point.
The key policy rate is reduced by 0.50 percentage point to 4.75 per cent with effect from 30 October 2008.
1) Special drawing rights, IMF. Currently, XDR is comprised of 40 per cent USD, 39 per cent EUR, 11 per cent GBP and 10 per cent JPY. As of 27 October 2008, XDR 1 = NOK 10.5.