Economic developments

The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting on 5 May:

• On 9 May, the EU and the IMF agreed on extensive support measures for countries experiencing market financing difficulties, including a loan package with an upper limit of EUR 750bn. At the same time, the European Central Bank began to purchase government bonds.
• Long-term government bond yields abroad have shown wide fluctuations, particularly in countries running large government deficits. For Greece, the yield spread against German ten-year government bonds has fallen by 0.6 percentage point to 6.7 per cent. Spreads have widened by 0.5 percentage point for Spain and 0.1 percentage point for Ireland. 
• The euro has depreciated considerably against the US dollar and several other currencies.
• On 19 June, China’s central bank announced that it would increase RMB exchange rate flexibility and pointed out that there is no scope for a substantial appreciation of the exchange rate.
• Equity prices have also fluctuated considerably. Leading European stock indices have edged up, while leading US and Asian stock indices have fallen. The Oslo Børs benchmark index has remained broadly unchanged.
• Activity in emerging economies remains robust. Manufacturing output abroad has continued to rise. Growth in private consumption is moderate in many advanced economies.
• Underlying consumer price inflation is low and falling in many countries. Inflation expectations remain stable in most advanced economies.
• Market participants expect central bank key rates among many of Norway’s trading partners to be raised around the end of the year. Longer-term key rate expectations have fallen.
• The spot price of Brent Blend oil has fallen by 10 per cent. In the past five trading days, the spot price has averaged USD 77 per barrel. The Economist commodity-price index has decreased by 4 per cent in XDR terms [1]. Dry cargo freight rates have fallen by 16 per cent.
• The import-weighted krone exchange rate (I-44) has depreciated by 2.1 per cent. 
• The turbulence in financial markets has had an impact on money markets abroad and in Norway. So far in 2010 Q2, the premium on three-month money market rates in Norway has been 0.2 percentage point higher than assumed in the March Monetary Policy Report. 
• The interest rate differential against trading partners is now approximately 2 percentage points. 
• Risk premiums on banks’ long-term market funding have risen. According to DnB NOR’s estimates for traded prices, premiums on 5-year bank bonds have increased by 0.25 percentage point. Premiums on OMF covered bonds have increased by approximately 0.1 percentage point.
• According to figures from Norsk familieøkonomi, lending rates have been raised by several of the largest banks. Weighted residential mortgage lending rates have increased by about 0.15 percentage point [2].
• In the year to May 2010 the consumer price index (CPI) rose by 2.5 per cent. Adjusted for tax changes and excluding temporary changes in energy prices (CPIXE), consumer prices rose by 1.9 per cent. Other indicators of underlying inflation were between 1.5 and 3.0 per cent. According to Perduco’s expectations survey, long-term inflation expectations edged up in Q2.
• This year’s wage settlement indicates that wage growth will be slightly lower than projected in the March Monetary Policy Report.
• Registered unemployment stood at a seasonally adjusted 2.8 per cent of the labour force in May, down from 2.9 per cent in April. According to Statistics Norway’s labour force survey (LFS), employment fell by 1000 in the period February to April compared with the three-month period to January 2010. 
• The enterprises in Norges Bank’s regional network interviewed at the end of April and in the first half of May reported low capacity utilisation and moderate growth so far this year. They expected continued moderate growth ahead. The enterprises reported that employment has risen somewhat in the past three months and that they expected a slight increase ahead. 
• Preliminary seasonally adjusted figures from the quarterly national accounts show that mainland GDP grew by 0.1 per cent from 2009 Q4 to 2010 Q1. The production index for building and construction has been revised since the latest national accounts figures were published and shows that production was considerably higher in 2009 and 2010 Q1. GDP and capacity utilisation levels at the beginning of 2010 were therefore probably as projected in the March Monetary Policy Report.
• The index for household spending on goods fell by a seasonally adjusted 0.2 per cent from March to April and has now fallen for three consecutive months. 
• Gross domestic debt (C2) in the private and municipal sector increased by 4.0 per cent in the year to April 2010. Household debt grew by 6.3 per cent. Debt among non-financial enterprises is still falling. 
• According to house price statistics from the real estate industry, house prices rose by a seasonally adjusted 0.3 per cent in May. House prices were 4.1 per cent higher than at the peak level in June 2007 and had increased by 16.0 per cent since the trough in November 2008. 
• According to building statistics, the number of housing starts was a seasonally adjusted 10 per cent higher in the period February to April than in the three-month period to January. The number of other building starts rose by 7 per cent in the same period.
• The value of traditional merchandise exports increased by 2.9 per cent adjusted for seasonal variations in the period March to May compared with the previous three-month period. The value of traditional merchandise imports rose by 10.4 per cent in the same period.
• Seasonally adjusted manufacturing output in the period February to April was 0.9 per cent higher than in the previous three-month period. 
• According to order statistics, the value of new manufacturing orders rose by about 5 per cent from 2009 Q4 to 2010 Q1, adjusted for seasonal variations [3]. In building and construction, the value of new orders fell by about 5 per cent in the same period. Order stocks fell in manufacturing and increased in building and construction.
• According to Statistics Norway’s investment intentions survey for 2010 Q2, the value of investment in manufacturing, mining and electricity is estimated to be 13 per cent lower in 2010 than in the corresponding survey for 2009. Investment in 2011 is estimated to be 8 per cent higher than the projection for 2010 published at the same time last year.
• According to Statistics Norway’s investment intentions survey for 2010 Q2, the value of investment in oil and gas production is estimated to be 4 per cent lower than in the corresponding survey for 2009. Investment in 2011 is estimated to be 8 per cent higher than the projection for 2010 published at the same time last year.
• In the Revised National Budget for 2010, the cyclically adjusted non-oil deficit on the central government budget for 2010 is estimated at NOK 131.5 billion. This is equivalent to 5.0 per cent of the capital in the Government Pension Fund Global.
  

Assessment

Growth in the global economy has so far in 2010 been stronger than envisaged earlier.  Commodity prices remain high. However, financial market turbulence has continued despite the extensive measures implemented by the EU, the IMF and the European Central Bank. Government bond yields in countries with weak public finances have remained high. The spread between money market rates and central bank key rates has widened. Many European countries are compelled to implement substantial fiscal tightening. This will dampen economic activity ahead and may have an impact on other countries, both within and outside Europe. Central bank key rate expectations have fallen markedly in many countries.

The recovery in the Norwegian economy is continuing, but probably at a somewhat slower pace than expected earlier. The economic outlook is more subdued as a result of developments in Europe. Underlying inflation is around 2 per cent and is expected to drift down further in the period to the end of the year. Both the consideration of keeping consumer price inflation close to the inflation target and the consideration of stabilising developments in output and employment imply a low interest rate.

Lower interest rates abroad and weaker prospects for Europe, higher money market premiums in Norway, somewhat lower growth in the Norwegian economy ahead and slightly lower wage growth suggest that the key policy rate should be raised somewhat later than projected in the March Monetary Policy Report.

The risk of prolonged turbulence in financial markets, resulting in a weakened outlook for inflation, output and employment in the Norwegian economy, suggests that the increase in the key policy rate should be postponed. On the other hand, interest rates in Norway are low. The consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat further ahead suggests that the interest rate should be brought closer to a more normal level.

An overall assessment of the outlook and the balance of risks suggests that the key policy rate should be held at the current level for a period and then gradually raised towards a more normal level. The Executive Board’s strategy is that the key policy rate should be in the interval 1½-2½ per cent in the period to the publication of the next Monetary Policy Report on 27 October unless the Norwegian economy is exposed to new major shocks. The Executive Board decided to leave the interest rate unchanged at this meeting.

Decision:

The key policy rate is left unchanged at 2 per cent.

Footnotes:

1. Special drawing rights, IMF. As of 21 June XDR 1 = NOK 9.36

2. New variable-rate residential mortgages of NOK 1 million, within 60 per cent of the purchase price

3. Norges Bank’s adjustment for seasonal variations