Norges Bank's Monetary Policy and Financial Stability Committee decided to raise the policy rate from 2.75% to 3% at its meeting on 22 March. There is considerable uncertainty about future economic developments, but the Committee’s current assessment of the outlook and balance of risks implies that the policy rate will most likely be raised further in May.

Improved international growth prospects

Consumer price inflation among Norway’s main trading partners has receded somewhat in recent months but is still high. Gas and electricity prices have fallen substantially, and futures prices are lower than in December. The decline in energy prices has contributed to curbing consumer price inflation, and in some countries underlying inflation has also moderated slightly. Global freight rates have declined further and are close to pre-pandemic levels.

Economic activity among trading partners softened a little in 2022 Q4. High consumer price inflation and rising interest rates are weakening household purchasing power and dampening activity. At the same time, lower gas and electricity prices will help underpin activity in 2023, particularly in the euro area. The lifting of containment measures in China will also provide additional impetus to global activity. GDP growth among Norway’s trading partners is expected to be subdued in 2023 but somewhat higher than anticipated earlier. Labour markets are tight, and wage growth is high in many countries. This may contribute to sustaining underlying inflation.

High inflation has prompted central banks in many of Norway’s trading partner countries to raise policy rates to the highest levels since the 2008 financial crisis. In recent weeks, problems at certain banks in the US and Switzerland have led to heightened financial market volatility. Global equity indexes have declined, oil prices have dropped and expectations for both Norwegian and international policy rates have decreased markedly. Market-based expectations for policy rates among Norway’s main trading partners are nevertheless somewhat higher overall than in December.

Significantly weaker krone

Over the past year, international interest rates have risen more than Norwegian interest rates. Combined with the recent increase in financial market turbulence, this has likely caused the krone exchange rate to depreciate, and the krone is now significantly weaker than projected in the December Report. The risk premiums in the money market and bond market have increased a little in recent weeks. Norwegian banks are well poised to weather losses and market turbulence given their solid profitability, capital adequacy and liquidity. Creditworthy households and firms appear to have ample access to credit. Interest rates on corporate loans have increased a little since December, and residential mortgage rates have risen broadly in line with expectations.

Improved growth outlook for Norway too

There is a high level of activity in the Norwegian economy. Norwegian mainland GDP increased further in 2022 Q4 and was higher in January than projected in December. Around the end of 2022, car purchases contributed to a marked increase in household consumption, most likely because car purchases were brought forward due to the announced car tax changes from 2023. Low car sales so far this year are expected to push down economic activity a little in 2023 Q1.

The labour market is tight. Employment has risen further and has been higher than projected. Unemployment has remained low. At the same time, labour shortages appear to have eased. The share of enterprises in Norges Bank’s Regional Network reporting that labour shortages are limiting output fell further in 2023 Q1.

Regional Network enterprises report some improvement in the outlook since the end of 2022, and now expect activity to hold steady in the period to summer. Enterprises also report slightly stronger profitability. There are wide differences across industries. Oil services contacts expect a sharp rise in activity as a result of high investment in the petroleum industry, while the construction industry expects a fall in production, partly owing to weak new home sales. Prices for existing homes have been higher than expected, and the number of unsold homes has declined. Nevertheless, house prices are expected to fall slightly ahead.

There are prospects that growth in the Norwegian economy will slow in 2023, but that activity will be higher than projected in the December Report. Strong petroleum investment and a rise in exports are expected to contribute to sustaining activity, while a substantial decline in household real disposable income pushes down consumption in 2023. The saving ratio fell markedly towards the end of 2022, and the current projections indicate that households will continue to draw on savings this year. Higher real wage growth is expected to push up consumption further ahead. Substantial investments related to climate transition are also expected to boost activity further out.

Prospects of high inflation for a longer period

Inflation in Norway is high and markedly above the target of 2%. The 12-month rise in the consumer price index (CPI) has slowed slightly since autumn and was 6.3% in February, lower than projected in the December Report. Underlying inflation indicators have risen a little since December. The 12-month rise in the CPI adjusted for tax changes and excluding energy products (CPI-ATE) was 5.9% in February, as projected earlier. Prices for many goods have risen rapidly, and higher services prices have recently become an increasingly prominent driver of inflation.

Inflation expectations have risen over the past year, according to Norges Bank's expectations survey. Long-term expectations are somewhat above 2%.

Wage growth increased to 4.3% in 2022 and was higher than projected. The rise in wage growth must partly be seen in the context of a tight labour market. At the same time, wage expectations for 2023 have increased, and the social partners expect wage growth to be higher in 2023 than in 2022. Annual wage growth in 2023 is now projected at 5.1%, which is higher than in the December Report.

Lower energy prices are expected to curb consumer price inflation ahead, while the past depreciation of the krone and higher wage growth will contribute to sustaining underlying inflation for longer.

Policy rate raised to 3%

The objective 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 counteracting the build-up of financial imbalances.

The Committee assesses that a higher policy rate is needed to curb inflation. Inflation is markedly above target. Growth in the Norwegian economy is slowing, but economic activity remains high. The labour market is tight, and wage growth is on the rise.

Since the December Report, energy prices have shown a pronounced fall, and consumer price inflation has been lower than projected. On the other hand, unemployment has been a little lower than projected, and there are signs that the slowdown in the Norwegian economy will be less pronounced than expected in December. Higher wage growth and a weaker krone than projected earlier push up inflation ahead. It is therefore the Committee’s view that the policy rate needs to be increased to a somewhat higher level ahead than projected earlier in order to bring inflation down to target.

The policy rate forecast has been revised up from the December Report and indicates a rise in the policy rate to around 3.5% in summer. Inflation is projected to moderate and approach the target somewhat further ahead. Capacity utilisation is expected to decline and lie somewhat below a normal level in the coming years. Unemployment is set to increase somewhat, albeit from a low level.

The future path of the policy rate will depend on economic developments. In its discussion of the balance of risks, the Committee was concerned with the substantial uncertainty over the potential impact of the turbulence in financial markets on financial conditions and the prospects for the Norwegian economy. There is also uncertainty about the future path of the krone and the potential effects of high inflation on wage and price formation. At the same time, the effects of the past rate hikes are not yet fully evident. Moreover, it is uncertain to what extent households will tighten consumption in response to high inflation and higher interest rates.

If the krone proves weaker than projected, or pressures in the economy persist, a higher policy rate than currently projected may be needed to bring inflation down to target. If inflation falls faster or unemployment rises more than projected, the policy rate may be lower than projected.

The Committee voted unanimously to raise the policy rate by 0.25 percentage point to 3% at its meeting on March 22. There is considerable uncertainty about future economic developments, but the Committee’s current assessment of the outlook and balance of risks implies that the policy rate will most likely be raised further in May.

 

Ida Wolden Bache
Pål Longva
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

 

22 March 2023