Monetary policy assessment

Activity in the Norwegian economy is high, with little spare capacity. Inflation is markedly above the 2% target. Since the March 2022 Monetary Policy Report, unemployment has fallen more than expected, and inflation has risen faster than projected. With rising wage growth and imported goods inflation, there are prospects that inflation will remain above the target for some time. Prospects for a more prolonged period of high inflation suggest a tighter monetary policy than projected earlier.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.75% to 1.25% at its meeting on 22 June. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further to 1.5% in August.

High inflation and weaker global growth outlook

Economic activity among Norway’s trading partners continued to rise broadly as expected in 2022 Q1. Labour market conditions have continued to improve, and unemployment has returned to pre-pandemic levels in many countries. Wage growth is on the rise and has been higher than projected in the March Report.

High energy prices and the combination of strong demand and supply constraints have led to a pronounced rise in global consumer price inflation. Since March, underlying inflation among trading partners has risen more than projected. High inflation is broad-based, and both goods and services inflation is high in many countries. Energy and food prices remain elevated, partly owing to the war in Ukraine. Oil prices have risen further, while spot gas prices are little changed. Oil and gas futures prices are higher than in March. Freight rates from China to Europe have fallen.

Chart A High inflation among trading partners1

Consumer prices. Twelve-month change. Percent

Uncertainty about the outlook for global growth and inflation has resulted in considerable financial market volatility. Global policy rate expectations have risen substantially since the March Report. A number of central banks have raised policy rates in order to tame inflation, and many have signalled a faster rate rise ahead. Long-term interest rates have also risen since March. Corporate bond risk premiums have increased, and global equity indexes have fallen.

High inflation and higher interest rates are reducing household purchasing power and are likely to curb consumption growth in many countries ahead. Along with intermediate goods shortages and production constraints, this is expected to dampen global economic growth. The projections for trading partner growth are now lower than in the March Report, while the projections for underlying inflation have been revised up.

The krone has depreciated and is weaker than projected. Norwegian money market premiums have declined. Norwegian market rates have moved up, reflecting expectations of further policy rate rises through the year. The rise in residential mortgage rates has been approximately as expected.

Chart B Expectations of a faster policy rate rise among trading partners2

Policy rates and estimated forward rates in selected countries. Percent

High activity and little spare capacity in the Norwegian economy

Economic activity has picked up quickly following the decline caused by the Omicron wave in winter. Mainland GDP was a little lower in April than projected in the previous Report. At the same time, there was strong growth in the sectors that had been most affected by pandemic-related restrictions. Household consumption has risen further and has been a little higher than projected. Services consumption moved up quickly through spring and is now back at pre-2020 levels, while demand for goods has been higher than expected.

Chart C Activity has picked up quickly since the turn of year3

GDP for mainland Norway. Seasonally adjusted. Index. February 2020 = 100

Employment has continued to rise, and the labour market is tight. In May, Norges Bank’s Regional Network contacts reported growing shortages of labour and intermediate goods. Contacts expected activity growth to slow somewhat over the next six months, with many citing capacity constraints as the reason for the slowdown. The share of contacts reporting capacity problems and output constraints due to labour shortages is now just as high as around the cyclical peak preceding the financial crisis. Strong demand for labour is confirmed by the high number of job vacancies. Seasonally adjusted unemployment fell to 1.7% in May, which is lower than projected in the March Report.

Chart D Firms report high capacity utilisation4

Capacity utilisation and labour shortages according to the Regional Network. Percentage shares

After a period of a rapid post-pandemic recovery, activity in the Norwegian economy has risen to a high level. There are prospects of somewhat slower growth ahead. Higher inflation and rising interest rates will likely curb growth in household consumption in the coming years. At the same time, solid growth in petroleum investment and business investment is expected to help lift activity.

The Revised National Budget for 2022 indicates a fiscal stance broadly in line with that assumed and implies a somewhat tighter fiscal policy in 2022 than in 2021. Petroleum revenue spending remains elevated in 2022, partly reflecting extraordinary pandemic-related spending, government support for electricity bills and measures related to the war in Ukraine.

Turnover in the market for existing homes has been high, and house price inflation has been higher than projected in recent months. Household credit growth has been a little lower than projected.

Inflation above the target

Inflation in Norway has climbed further. The 12-month rise in the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE) was 3.4% in May, which was higher than projected. The increase in CPI-ATE inflation appears to be broad-based. Prices for both imported goods and domestically produced goods and services have risen more than projected. Wage growth is on the rise, and producer prices for imported goods have increased more than expected. In conjunction with the krone depreciation, this will push up inflation ahead.

Other indicators of underlying inflation have also risen and are, overall, higher than the CPI-ATE. Longer-term inflation expectations have risen slightly and are now somewhat above 2%.

The overall consumer price index (CPI) has been pushed up by high energy prices. Government support to compensate for the surge in electricity prices has curbed the increase in energy prices faced by households, but 12-month CPI inflation was nevertheless 5.7% in May. This is considerably higher than projected in the March Report, owing in part to a faster-than-expected rise in energy prices.

This year’s wage settlements so far appear to be consistent with the wage growth projection in the March Report. Nevertheless, a tight labour market may result in somewhat faster wage growth than projected earlier. Annual wage growth in 2022 is now projected at 3.9%, which is higher than in March. The projection for wage growth is in line with the wage expectations of the social partners and Regional Network contacts.

Chart E Inflation is above target5

CPI and CPI-ATE. Twelve-month change. Percent

Need for higher interest rates in Norway

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.

Activity in the Norwegian economy is high, with little spare capacity. Unemployment has fallen more than expected and is at a very low level. Inflation is markedly above the target. Underlying inflation has picked up quickly and has been higher than projected. With rising wage growth and imported goods inflation, there are prospects that inflation will remain above the target for some time.

The policy rate is still low, and monetary policy is expansionary. In the Committee’s assessment, a markedly higher policy rate is needed to stabilise inflation around the target. Given a tight labour market, employment will likely remain high even with a higher policy rate ahead.

Prospects for a more prolonged period of high inflation suggest a faster rise in the policy rate than projected earlier. A faster rate rise now will reduce the risk of inflation remaining high and the need for a sharper tightening of monetary policy further out.

The policy rate forecast has been revised up from the March Report and indicates a rise in the policy rate to around 3% in the period to summer 2023. This is above what is estimated to be a neutral policy rate. With such a path for the policy rate, there are prospects that inflation will drift down and approach target further out. Capacity utilisation is projected to remain above a normal level in the coming years, and unemployment is projected to remain low. House price inflation and credit growth are expected to moderate.

Chart F A higher policy rate helps to achieve the objectives of monetary policy6

In its discussion of the balance of risks, the Committee was concerned with the risk of inflation moving higher than anticipated against the background of little spare capacity in the Norwegian economy, sustained global inflationary pressures and a weaker krone. In that case, the policy rate may be raised more than currently projected. On the other hand, there is also a risk that rapid rate increases abroad will lead to an abrupt slowdown in growth, with global inflationary pressures easing faster than assumed. The rise in interest rates in Norway may also cool down the housing market and curb household consumption to a greater extent than expected. If inflation and capacity utilisation fall faster than projected, the policy rate may be raised less than currently projected.

The Committee decided unanimously to raise the policy rate to 1.25%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further to 1.5% in August.

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

22 June 2022

Assessment of the countercyclical capital buffer requirement

In March, the decision was made to raise the countercyclical capital buffer rate to 2.5%, effective from 31 March 2023. At its meeting on 22 June, Norges Bank’s Monetary Policy and Financial Stability Committee decided to maintain this requirement.

Norges Bank sets the countercyclical capital buffer rate four times a year. In its work on setting the buffer rate, Norges Bank exchanges relevant information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway). Norges Bank’s framework for the countercyclical capital buffer has recently been updated and is described in Norges Bank Papers 4/2022. At the same time, Norges Bank has published a framework for advice on the systemic risk buffer (see Norges Bank Papers 5/2022).

The countercyclical capital buffer requirement is meant to reflect the assessment of cyclical vulnerabilities in the financial system. Experience shows that economic downturns tend to be more pronounced following a period of sharp rises in credit and asset prices.

As a main rule, banks should hold a countercyclical capital buffer. Such a buffer strengthens banks’ solvency and mitigates the risk that banks amplify an economic downturn. The countercyclical capital buffer is not an instrument for managing credit growth or asset prices. Under the rules, the countercyclical capital buffer should, in principle, range between 0% and 2.5%. The buffer rate should normally be in the higher part of this range. This is supported by analyses of the need for time-varying capital buffers, such as stress tests. In the event of a downturn that causes or potentially causes clearly reduced access to credit, the countercyclical capital buffer rate should be lowered.

Activity in the Norwegian economy is high, with little spare capacity. Activity has picked up quickly following the decline owing to the Omicron wave in winter. Unemployment has declined more than expected in the March 2022 Monetary Policy Report and is at a very low level.

Creditworthy firms and households appear to have ample access to credit. Banks reported unchanged credit standards in 2022 Q1 and expected no changes in 2022 Q2. Bond market risk premiums have risen since March.

Uncertainty about the outlook for global growth and inflation has recently resulted in considerable financial market volatility. An abrupt rise in foreign risk premiums and a sharp fall in asset prices may affect the Norwegian financial system. Owing to vulnerabilities in the financial system, such shocks may have a more pronounced impact on the Norwegian economy.

Credit growth and property price inflation slowed in the course of 2021 after having been high during the pandemic. In 2022, house price inflation has moved up again but is expected to moderate ahead. Commercial property price inflation has also moved up recently, but commercial property prices are expected to edge down ahead on the back of gradually rising yields. However, yields are low, and an abrupt rise can lead to a more pronounced fall in prices. On the whole, the assessment of cyclical vulnerabilities is approximately the same as before the pandemic.

Because they are solvent, liquid and highly profitable, Norwegian banks are resilient to shocks. Banks are well equipped to meet the approved countercyclical capital buffer requirement while maintaining credit supply.

The Committee unanimously decided to keep the countercyclical capital buffer rate at 2.5%.

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

22 June 2022

1 The global economy

The upswing in economic activity among Norway’s trading partners in 2022 Q1 was approximately in line with expectations. Headline inflation is still on the rise in many countries, and the projections for underlying inflation have been revised up. High inflation lowers household purchasing power. The projections for trading partner GDP growth in 2022 and 2023 have been revised down. The war in Ukraine is contributing to continued high oil and gas prices and volatility in global financial markets. Market rates indicate higher policy rate expectations abroad compared with the March 2022 Monetary Policy Report.

Lower household purchasing power is dampening growth

In the March Report, it was assumed that high inflation, tighter financial conditions and increased uncertainty among household and firms as a result of the war in Ukraine would curb activity and that trading partner GDP growth would slow in Q1. Overall, growth has been approximately in line with the projections in the March Report, although growth rates vary across countries. In the US and Sweden, activity fell between 2021 Q4 and 2022 Q1, while the euro area, UK and China recorded solid growth in the same period.

Growth prospects for the quarters ahead appear to be weaker than in March. In China, strict pandemic-related restrictions have been in place in several large cities in response to the recent months’ Omicron wave. Current indicators suggest a fall in activity between Q1 and Q2. Delays in goods production and shipping in China are likely to contribute further to delivery problems for some goods in the US and Europe.

Consumer price and producer price inflation have been very high in recent months. Oil and gas futures prices have risen since the March Report, and prices for a range of commodities are very high (see "Futures prices for energy and agricultural products continue to rise"). Increased goods prices will depress household purchasing power, push up prices for intermediate goods and dampen economic activity. Household confidence fell in spring to the levels observed during the 2008 financial crisis. At the same time, market policy rate expectations have continued to rise. Tighter financial conditions and uncertainty among households and firms will also likely dampen consumption and investment. It is nonetheless assumed that households will maintain consumption by drawing on excess savings accumulated during the pandemic (Chart 1.1). The projections for trading partner GDP growth for 2022 and 2023 have been revised down from the March Report (Chart 1.2).

Chart 1.1 Households saved through the pandemic1

Savings ratio. Percent

Chart 1.2 Lower GDP growth in the coming quarters2

GDP for trading partners. Quarterly change. Percent

The expansionary monetary and fiscal policies of recent years are still making a positive contribution to activity in most countries. It is assumed that monetary policy will be tightened ahead in line with market policy rate expectations. Higher defence expenditure and energy investment in Europe will likely boost activity further out in the projection period. In China, the reorientation of policy towards more balanced growth driven by domestic conditions is expected to continue, and growth is expected to be lower in the period ahead than in the pre-pandemic years. Trading partner GDP growth is projected to slow gradually from 3% in 2022 to about 2% in 2024 (Annex Table 1). Trading partner imports are projected to increase by close to 6% in 2022 and about 3.5% in 2023.

Very high consumer price inflation

Over the past year, pandemic-related supply and demand conditions have contributed to a marked rise in inflation among Norway’s main trading partners. In spring, the war in Ukraine contributed to high commodity prices. The 12-month rise in the headline consumer price index (CPI) moved up to over 8% in the US and euro area in spring (Chart 1.3). The rise in energy and food prices made up over half of the 12-month rise in the euro area, and underlying consumer price inflation was 3.8% in May. In the US, underlying consumer price inflation was 6% in May. In recent months, underlying inflation among all Norway’s main trading partners has been higher than projected in March.

Chart 1.3 Very high consumer price inflation3

Consumer prices. Twelve-month change. Percent

Freight rates for goods from China to Europe and the US fell in spring and are now at the same level as in summer 2021 but are still far higher than before the pandemic. It is assumed that the rise in business costs related to the increases in energy and other commodity prices and goods freight rates will to some extent be passed on to consumer prices for goods and services and thereby push up underlying consumer price inflation.

Wage growth among trading partners has been higher than expected in the March Report. Labour demand is high, and the number of job vacancies has increased markedly. In many countries, unemployment has fallen to pre-pandemic levels. The projections for wage growth among trading partners for the years ahead have been revised up. Long-term market-based inflation expectations for the US are little changed since the March Report, while they have edged down for the euro area, and are close to the inflation targets for both the US and euro area. Underlying consumer price inflation in 2022 is expected to be close to 6% in the US and around 3.5% in the euro area. Underlying inflation for trading partners as a whole is projected to slow to 3% in 2023, before gradually settling at 2%. The projections for 2022 and 2023 have been revised up from the March Report.

Producer price inflation for consumer goods imported to Norway (IPK index), in foreign currency terms, has been higher than expected. In recent months, the 12-month rise has moved up for all sub-indices (Chart 1.4). The rise in food prices has been particularly steep. The war in Ukraine will likely contribute to keeping food prices high ahead. The projections for 2022 and 2023 have been revised up considerably from the March Report (Annex Table 1).

Chart 1.4 Strong external inflationary impulses4

IPK. Twelve-month change. Percent

Higher policy rate expectations abroad

There has been considerable volatility in global financial markets since the March Report. The fluctuations have partly been amplified by low levels of liquidity. Long-term interest rates have risen markedly (Chart 1.5). Higher interest rates have increased uncertainty about the growth outlook. European and US equity indexes have fallen considerably, and corporate bond risk premiums have risen further, particularly for high-yield issuers.

Chart 1.5 Long-term interest rates have edged up5

Yields on 10-year government bonds in selected countries. Percent

Rapidly rising inflation and concerns that wage and price inflation may remain high ahead have led central banks to tighten monetary policy more than envisaged by market participants in March. Since the March Report, the US Federal Reserve and the Bank of England have raised their policy rates by 1.25 and 0.75 percentage points respectively to 1.5% and 1.25%. The central bank of Sweden has raised its policy rate from 0% to 0.25%, while the European Central Bank has signalled that its first policy rate increase will be in July. Central banks are signalling further tightening ahead, and market rates show that policy rate expectations have risen markedly since the March Report. Long-term government bond yields have largely tracked policy rate expectations.

In addition to raising policy rates, many central banks are in the process of reducing their balance sheets. Large-scale asset purchases through the pandemic led to a substantial expansion of central bank balance sheets in many countries. The balance sheet reductions could in isolation lead to an increase in long-term interest rates. However, central banks have signalled that balance sheets will not be used actively to tighten financial conditions.

Uncertainty about economic developments

Uncertainty about global economic developments has increased because of the war in Ukraine and the pandemic-related lockdowns in China. With high inflation abroad and tighter financial conditions in many countries, there is a risk of more pronounced effects on financial markets and on household consumption and business investment than currently envisaged. In addition, uncertainty persists with respect to the scale and duration of pandemic-related supply and demand conditions and the implications for global growth and inflation.

2 Financial conditions

Household lending rates have risen further, while there has been little change in corporate lending rates since the March 2022 Monetary Policy Report. A further tightening of financial conditions is expected in response to additional policy rate hikes.

Interest rates among Norway’s trading partners have risen more than rates in Norway, which has contributed to weakening the krone exchange rate. Lower risk appetite in financial markets has pulled in the same direction. The krone is projected to appreciate through the projection period.

2.1 Household and corporate lending rates

Market participants expect a higher policy rate

Market participants’ policy rate expectations have moved higher since the publication of the March Report. Market-implied rates indicate that the policy rate reaches a peak at just above 3% in the first half of 2024, which is higher than implied by the policy rate path in the March Report.

Higher policy rate expectations in Norway and among Norway’s trading partners have also led to a rise in long-term interest rates since the March Report.

Residential mortgage rates have risen further

Household borrowing costs have risen in pace with policy rate hikes over the past year. As with previous hikes, after the monetary policy meeting in March this year, the largest banks announced their intention to raise residential mortgage rates by up to 0.25 percentage point. For existing loans, a six-week notification requirement applies, and the rate increases gradually took effect through spring. The average interest rate on outstanding mortgages was 2.2% at end-April. The average residential mortgage rate has moved broadly as projected in the March Report.

In the coming years, residential mortgage rates are expected to increase in response to further increases in the policy rate. In 2024, the average residential mortgage rate is projected to reach about 4.3% before falling somewhat towards the end of the projection period (Chart 2.1). The projection for the residential mortgage rate has been revised up less than the policy rate path since the March Report. This is because the pass-through from the policy rate to deposit rates is somewhat weaker than assumed in March. In isolation, banks will therefore not have to increase residential mortgage rates to the same extent in order to maintain profitability.

Chart 2.1 Higher lending rates1

Percent

The rise in long-term interest rates will push up the interest rate on fixed mortgages. The share of new fixed-rate mortgage loans rose slightly in March, but fixed-rate mortgages only account for 7% of total outstanding mortgages.

Lower money market premiums dampen tighter corporate financial conditions

In addition to the policy rate, corporate financing costs will also be affected by various risk premiums. The most widely used reference rate for firms’ bank loans and floating-rate market financing is the three-month money market rate, Nibor. Nibor reflects market policy rate expectations over the next three months and a risk premium, often referred to as the money market premium. Expectations that Norges Bank would raise the policy rate have in isolation pushed up Nibor since the March Report. A sharp fall in the money market premium has nevertheless led to small changes overall in Nibor.

The fall in the money market premium has dampened the tightening of firms’ financial conditions. The fall reflects higher structural liquidity in the banking system and lower US money market rates. So far in 2022 Q2, the money market premium has averaged around 0.35 percentage point (Chart 2.2), which is lower than projected. The money market premium is projected to remain at about 0.35 percentage point in the period ahead, which implies that Nibor will rise in pace with the policy rate.

Chart 2.2 Lower money market premium2

Percentage points

The interest rate on firms’ market financing includes a risk premium in addition to Nibor. This risk premium will affect the cost of new bond issues and has risen since March. Fixed-rate funding will also be more costly for firms due to the rise in long-term interest rates.

While global equity indexes have fallen, movements in the Oslo Børs Benchmark Index have on the whole been small since the March Report, mainly on account of higher oil and gas prices.

2.2 Krone exchange rate

Wide swings in the krone exchange rate

The krone exchange rate, as measured by the import-weighted exchange rate index I-44, is weaker than projected. Narrower interest rate differentials against Norway’s trading partners have weighed on the krone. Higher oil prices have pulled in the opposite direction. The krone has depreciated more than implied by the historical relationship between these variables, which may reflect a higher risk premium on the Norwegian krone. The risk premium may have moved up on the back of heightened uncertainty in global financial markets. This risk premium is expected to diminish over time and the krone to appreciate through the projection period (Chart 2.3). Lower oil prices ahead pull in the opposite direction.

Chart 2.3 Stronger krone in the coming years3

Import-weighted exchange rate index (I-44). Difference between three-month money market rate in Norway and among trading partners. Percentage points

The path of the krone exchange rate may differ from that projected. If global uncertainties subside faster than expected, the krone may appreciate more than projected. Should oil prices fall further or financial market uncertainty persist, the krone may remain weaker than projected.

3 The Norwegian economy

The Norwegian economy is running above potential. Activity has picked up after the pandemic-related restrictions were removed over winter. Unemployment has declined to low levels, and many firms are reporting labour shortages.

Inflation has increased in 2022, primarily owing to higher energy prices. Underlying inflation has also moved up in recent months and is now above the 2% inflation target. Higher labour costs and rising global inflationary pressures have pushed up inflation.

In the projections, higher inflation and interest rates weigh down on the economic upswing. The level of capacity utilisation rises in the period to autumn, before gradually declining. Global inflationary pressures subside from 2023, while high capacity utilisation pushes up wage and price inflation. Inflation is projected to be somewhat above 2% at the end of the projection period.

3.1 Output and demand

High level of economic activity in Norway

Economic activity in Norway has increased and unemployment has declined to low levels after the pandemic-related restrictions were lifted in mid-February. The rise in services activity, among the hardest hit by the pandemic, was a main driver behind the brisk growth in the mainland economy in February and March (Chart 3.1). At the same time, firms are experiencing difficulties covering their labour needs, which may have curbed the upswing to some extent. A temporary decline in production in the electricity and fishing industries contributed to the fall in activity in April. Activity in the mainland economy has been a little weaker than projected in the March 2020 Monetary Policy Report.

Chart 3.1 Solid growth after removal of pandemic-related restrictions1

GDP for mainland Norway. Monthly growth. Contribution to monthly growth. Seasonally adjusted. Percentage points

According to Norges Bank’s Regional Network survey, activity is expected to rise over the coming months (Chart 3.2). Services contacts expect solid growth but also expect households to spend a larger share abroad owing to the pickup in foreign travel. Retail trade contacts expect an increase in foreign travel and border shopping to pull down activity ahead. A large share of the contacts cite labour shortages and high capacity utilisation as constraints on production. Capacity utilisation is further discussed in "Higher capacity utilisation".

Chart 3.2 Firms expect sustained growth2

Reported and expected growth. Annualised. Seasonally adjusted. Percent

The reopening of society has provided a strong boost to household consumption, which lifts mainland growth in 2022 (Chart 3.3). Annual mainland GDP growth is projected at 3.5% in 2022, while the pace of growth slows thereafter as a result of capacity constraints, higher inflation and rising interest rates. Increased investments related to climate transition and petroleum sector investment in isolation push up growth in the coming years despite rising interest rates. Further out, annual mainland GDP growth slows to around 1%. The projections are somewhat lower than in the March Report.

Chart 3.3 Gradually slowing growth through the projection period3

GDP for mainland Norway. Annual growth. Contribution to annual growth. Percentage points

The expansionary fiscal stance during the pandemic has brought oil revenue spending to a high level (Chart 3.4). The Revised National Budget for 2022 indicates a somewhat tighter fiscal policy in 2022 than in 2021. Nevertheless, petroleum revenue spending remains high in 2022 owing to extraordinary expenditure relating to the handling of the pandemic, support for households’ electricity bills and measures relating to the war in Ukraine. Prospects that the economy will be running above potential imply a further tightening of the fiscal stance in 2023. Public demand was weaker than expected in 2022 Q1 and is a little lower ahead than projected in March. This is consistent with a somewhat lower-than-assumed structural, non-oil deficit, as estimated in the Revised National Budget for 2022.

Chart 3.4 Tighter fiscal policy ahead4

Public demand. Annual change. Structural non-oil deficit as a percentage of trend GDP. Percent

Lower consumption growth ahead

The pandemic has severely limited household consumption opportunities in recent years. Household consumption fell by 1.5% in 2022 Q1 after growing rapidly through autumn. The decline reflects the pandemic-related restrictions in place around the turn of the year. Household consumption has strengthened somewhat more than projected in the March Report (Chart 3.5). Household spending on services recovered rapidly and is now back to the levels prevailing before 2020. At the same time, demand for goods has held up. Foreign spending by Norwegian residents is still substantially lower than before the pandemic but is expected to rise ahead, although it will likely take some time before travel activity recovers to its pre-2020 level. This alone suggests that households will continue to spend more domestically in the coming period.

Chart 3.5 Weaker consumption growth in the coming years5

Household consumption. Constant prices. Seasonally adjusted. In billions of NOK

In recent months, household confidence indicators have weakened appreciably. This may be due to heightened uncertainty about the economic outlook, implying in isolation lower consumption, but is likely also related to the fact that higher prices and interest rates have dampened real household disposable income over the past year.

Increased employment and higher wage growth have the opposite effect. The excess savings accumulated during the pandemic give households room to increase consumption despite weaker growth in real disposable income. The effect of interest rates on consumption is further discussed in a box on "How do interest rates influence household disposable income and consumption?".

It is assumed that households wish to normalise consumption after several years of restricted consumption options. Updated figures show that saving fell faster than projected, which may indicate that consumption is returning to normal somewhat faster than expected. Growth in household consumption is projected at 6.5% in 2022. Low growth in real household disposable income is expected to curb consumption growth ahead. Annual growth in household consumption is projected to slow to just above 1% towards the end of the projection period.

Higher cost of materials dampens housing investment

House prices have continued to rise, and the rate of increase has been higher than projected in the March Report, reflecting continued high housing demand and the low number of unsold homes. House price inflation has been revised up slightly since the March Report but is still expected to slow over this year. The housing market is further discussed in Section 5.

Housing investment has been weaker than expected earlier. At the same time, prices for materials such as wood, steel and cement have been higher than anticipated. Regional Network contacts report that high prices for materials and labour shortages will dampen homebuilding activity ahead. Housing investment is projected to be somewhat lower in 2022 than in the March Report. Prices for materials are expected to moderate ahead, contributing to a rise in housing investment which will likely be curbed by higher interest rates on residential mortgage loans.

High business investment

After falling sharply in 2020, business investment recovered through 2021 and into 2022. Services investment has shown particularly strong growth over the past year and was higher than expected in 2022 Q1. Services firms in the Regional Network report plans to increase investment further over the next year. Growth in services investment is expected to slow further out as a result of higher interest rates, low growth in the Norwegian economy and the fact that the level of investment is high relative to services activity.

The climate transition will likely lead to a marked increase in investments in batteries, hydrogen, carbon capture, the processing industry and electricity. Investment in new and existing manufacturing will however be curbed by reduced power supply, high electricity prices in southern Norway, global supply bottlenecks and the rise in prices for intermediate and capital goods over the past year. Mainland business investment is projected to increase by close to 8% in 2022, before slowing to around 4% in the following years (Chart 3.6).

Chart 3.6 Higher mainland business investment6

Business investment in mainland Norway. Annual growth. Contribution to annual growth. Percentage points

Petroleum investment has declined in recent years owing to the fall in oil and gas prices to low levels in 2020 at the same time as a number of large projects were nearing completion. The decline has been cushioned by the temporary tax changes for oil companies introduced in June 2020 and the subsequent sharp rise in oil and gas prices through 2021. The temporary tax changes give oil companies strong incentives to launch development projects before 2023, and oil companies have announced a series of projects to be started before the end of the year. Petroleum investment is projected to show a marked rise between 2022 and 2025 (Chart 3.7), reinforced by expected high oil and gas prices ahead. Petroleum investment is expected to move down after 2025.

Chart 3.7 High petroleum investment in the years ahead7

Petroleum investment. Constant 2022 prices. In billions of NOK

Increased travel boosts exports and imports

The climate transition, the war in Ukraine and high petroleum prices are fuelling global investment in the petroleum and renewable energy sectors, resulting in brisk growth for Norwegian oil services exports. Foreign travel to Norway is still low compared with pre-pandemic levels but is expected to increase strongly ahead. At the same time, the increase will be curbed by lower household purchasing power abroad. Weaker growth prospects for Norway’s trading partners pull down on growth for other mainland exports. The krone is expected to appreciate over the projection period. In isolation, this suggests lower exports.

Imports are expected to grow strongly in the coming years. The main drivers this year are mainland business investment and a gradual normalisation of foreign travel by Norwegian residents. Imports will also be supported by brisk growth in electricity and petroleum investment ahead.

The projections are uncertain

There is considerable uncertainty related to the effects of the pandemic evolution in China and the war in Ukraine. Global supply chain disruptions may persist longer than expected. This may lead to lower output and investment both in Norway and abroad. If supply bottlenecks abate faster than expected, output and investment may show a stronger increase than projected.

High inflation and rising global interest rates may also dampen global activity more than envisaged. Exports may then prove to be weaker than expected.

It is also uncertain how households will respond to a marked increase in the cost of living. After a period of low inflation, very low interest rates and high debt burdens, the effect of higher living costs on consumption may be stronger than assumed (see "How do interest rates influence household disposable income and consumption?").

3.2 Labour market

Further tightening of labour market conditions

The labour market is tight. Employment is high and unemployment is low in an environment of substantial labour shortages. Both employment and unemployment returned to pre-pandemic levels in the course of autumn 2021. The employment rate is at its highest level in more than ten years (Chart 3.8). The rise in employment in recent quarters has been broadly based, but particularly strong in the industries most affected by pandemic-related conditions.

Chart 3.8 High employment rate8

Labour force as a share of the population aged 15–74. Seasonally adjusted. Percent

In 2022 Q1, employment increased broadly as expected by 0.4% (Chart 3.9). Employment in the hospitality sector dipped owing to the pandemic-related restrictions in place at the beginning of the year but recovered in April to reach a higher level than before the pandemic.

Chart 3.9 Employment has continued to rise9

Employment. In thousands. Seasonally adjusted

Since April 2021, the number of wage earners has increased by close to 150 000, reflecting a fall in the number of unemployed but also an increase in inflows into the labour market. Around 17 000 additional temporary foreign workers have come to Norway. In addition, more domestic workers have entered the labour market. They seem to be coming from all parts of the population irrespective of age, immigrant background and previous work experience.

At the end of May, 47 100 persons were registered as fully unemployed (Chart 3.10). Adjusted for normal seasonal variations, this accounts for 1.7% of the labour force. This is the lowest unemployment rate recorded since 2008 and lower than projected earlier. The extraordinary rules allowing longer furlough periods during the pandemic were lifted from 1 April. Many furloughed workers were then recalled to work, which likely contributed to the recent months’ decline in unemployment. The number of furloughed workers, which increased sharply when the pandemic broke out in 2020, is now back to the 2019 level. The number of partially unemployed has also shown a substantial fall recently and is now back to pre-pandemic levels.

Chart 3.10 Decline in number of unemployed10

Registered unemployed. In thousands

Strong demand for labour

The demand for labour has risen gradually since autumn 2020 and has continued to rise since the March Report. Half of Regional Network contacts now report output being constrained by labour shortages. This is the highest share recorded since before the financial crisis. The number of job vacancies has not been higher since Statistics Norway first started its sample vacancy survey in 2010 (Chart 3.11). According to statistics from the Norwegian Labour and Welfare Administration (NAV), the upward trend in job vacancies continued in April and May this year.

Chart 3.11 High number of job vacancies11

Job vacancies as a share of all jobs. Percent

Prospects for continued low unemployment

Employment is projected to continue to grow. In May, Regional Network contacts expected employment to rise at about the same pace over the next three months as in the previous three months. Services contacts expected the strongest growth, but petroleum service companies and other manufacturing also anticipate solid growth in the coming period.

In the projection, the Norwegian economy reaches a cyclical peak in the latter half of 2022. Employment growth then slows towards the end of 2022, followed by weak growth in employment in the following three years. Labour shortages dampen the further rise in employment.

The number of temporary foreign workers is expected to continue to rise ahead. In the light of tight labour market conditions in Eastern Europe, combined with an expected introduction of a ban on contract labour in construction in the Oslo fjord area, the number is not likely to reach the levels prevailing before the pandemic in the course of the projection period. The war in Ukraine is expected to lead to an increase in refugee inflows to Norway. A portion of these refugees are likely to enter the Norwegian labour market in the coming years.

Unemployment is projected to fall a little in the near term owing to brisk growth in employment. Unemployment then stabilises over autumn before rising slightly from 2023 (Chart 3.12). Unemployment nevertheless remains low throughout the projection period.

Chart 3.12 Unemployment is low12

Registered unemployed as a share of the labour force. Seasonally adjusted. Percent

The labour market projections are uncertain. The period of high demand for labour may have mobilised more labour market groups to join the workforce on a permanent basis, which may indicate that potential employment is higher than assumed. The tight labour market may also lead to higher-than-expected inflows of foreign workers to Norway. On the other hand, tight labour markets and high wage growth in their home countries may make it relatively less attractive to work in Norway so that inflows turn out to be lower than expected.

3.3 Costs and prices

Higher wage growth

Labour market tightening pushed up wage growth through 2021, with annual wage growth reaching 3.5% in 2021. In the March Report, wage growth was projected to rise further to 3.7% in 2022. Wage statistics for 2022 Q1 indicate that wages have risen broadly as projected. In the wage negotiations, the wage norm was set at 3.7% for manufacturing. Wage growth of 3.8% has been agreed on in most of the public sector.

Norges Bank’s Regional Network contacts have revised up their wage growth expectations since the March Report and now expect wages in their own enterprises to rise by 3.9% in 2022 (Chart 3.13). According to Norges Bank’s Expectations Survey, employers and economists have also revised up their expectations for wage growth in 2022. Employees, on the other hand, have lowered their expectations. Overall, the social partners now expect wage growth of 3.9%.

Chart 3.13 Wage growth has risen1

Annual wage growth. Percent

Many of those now entering employment earn lower-than-average wages. As in the March Report, it is assumed that this will in isolation pull down the average wage level somewhat in 2022 (see "Composition effects influence wage growth" on how composition effects influence wage growth).

A shortage of labour typically pushes up wage growth (Chart 3.14). The tightening of the labour market in recent months is expected to lead to somewhat higher wage growth through autumn than projected in the March Report. The Expectations Survey indicates lower business profitability, which may curb wage growth. On the other hand, Regional Network contacts report virtually unchanged profitability (Chart 3.15). Overall annual wage growth in 2022 is projected at 3.9%.

Chart 3.14 Labour shortages push up wage growth2

Annual wage growth and labour shortages

Chart 3.15 Lower business profitability3

Change in operating margins according to Regional Network contacts and the Expectations Survey

Wage growth expectations for 2023 have risen according to the Expectations Survey but still indicate lower wage growth in 2023 than in 2022. Nevertheless, higher inflation, high capacity utilisation and a shortage of labour are expected to push up wage growth further in 2023, and wage growth is projected at 4.5% in 2023 (Chart 3.16).

Chart 3.16 Prospects for high wage growth4

Annual growth. Percent

High oil and gas prices will likely boost mainland business activity and profitability, which in turn may push up wage growth. Gradually lower capacity utilisation is nevertheless expected to pull down wage growth further out in the projection period. Overall business profitability is projected to show little change in the coming years.

Higher inflation

Substantial energy price volatility in recent years has resulted in wide variations in the consumer price index (CPI). Annual CPI inflation was 1.3% in 2020 and 3.5% in 2021. In 2022, CPI inflation has risen further on the back of a surge in fuel and electricity prices, and 12-month CPI inflation was 5.7% in May, which is higher than projected in the March Report.

Underlying inflation has risen gradually from a low level since autumn 2021. In May 2022, 12-month CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) was 3.4% (Chart 3.17). This is higher than projected in the March Report. Indicators of underlying inflation averaged 3.6% in May. All of the indicators have risen in recent months and are well above the 2% target.

Chart 3.17 Inflation has risen5

CPI and indicators of underlying inflation. Twelve-month change. Percent

The 12-month rise in prices for domestically produced goods and services in the CPI-ATE was 3.0% in May, which is higher than projected earlier. The rise reflects higher costs for electricity, materials and other intermediate goods and the rise in wage growth. In addition, weak developments in underlying productivity have probably also made a contribution. The same factors are expected to lift domestic inflation further in the near term.

Domestic inflation is typically driven by cyclical fluctuations (Chart 3.18). High labour demand pushes up wage growth, and when demand for goods and services is high, as is the case today, it is easier for firms to pass on increased costs to domestic prices. Given that underlying productivity growth appears to have been weaker than projected, domestic inflation may accelerate for a lower rate of wage growth than assumed earlier. A positive output gap and high wage growth are expected to keep domestic inflation elevated in the coming years.

Chart 3.18 Higher capacity utilisation leads to higher domestic inflation6

Domestically produced goods and services in the CPI-ATE. Four-quarter change. Output gap five quarters earlier

Imported consumer goods inflation has also picked up in recent months (Chart 3.19), reflecting stronger external inflationary impulses (Chart 3.20). In May, 12-month inflation was 4.3%, which is higher than projected. Inflation developments are further discussed in "Inflation in Norway in an international context".

Chart 3.19 Prospects for high domestic inflation7

Domestically produced goods and services and imported goods in the CPI-ATE. Four-quarter change. Percent

Chart 3.20 Strong external inflationary impulses8

Producer prices for imported consumer goods with freight rates. Annual change. Percent

Imported consumer goods inflation is projected to remain elevated over the remainder of the year, owing to strong external inflationary impulses and the recent krone depreciation. External inflationary impulses are expected to ease from next year. Combined with a gradually stronger krone, this is expected to dampen imported inflation in the years ahead.

Four-quarter CPI-ATE inflation is projected to reach 4.1% towards the end of 2022, before edging down gradually to 2.6% at the end of 2025. The inflation projections have been revised up compared with the March Report.

Fuel prices are expected to edge down in 2022 and 2023. Energy prices in the CPI are substantially curbed by the electricity bills support scheme, which we assume will apply until the end of March 2023. Energy prices in the CPI are projected to drift down over this year, before moving up in 2023.

CPI inflation is projected to remain high through summer 2022 and then to slow through autumn. Annual CPI inflation is projected to reach 4.6% in 2022, before slowing to 2.7% in 2025.

Inflation expectations, as measured by Norges Bank’s Expectations Survey, have increased recently. Inflation expectations one and two years ahead are now above 3%. Longer-term inflation expectations are lower, but above the 2% target.

Decline in real wages in 2022

Annual wages and the CPI increased at about the same pace in 2021, so that real wages remained unchanged. In the Bank’s projections for 2022, the CPI rises more than wages, so that real wages decline. From 2023, annual wage growth is expected to be higher than CPI inflation, and real wages are expected to rise by an annual average of around 1½% in the next three years. This is higher than the estimated trend growth in productivity. However, owing to the rise in petroleum prices, Norway’s terms of trade have improved considerably and based on past experience some of this rise will benefit wage earners. The projections for real wage growth have been revised down since the March Report, reflecting the downward revision of the productivity projections in this Report and the upward revision of the projections for electricity price inflation and imported goods inflation.

There is substantial uncertainty surrounding price and wage inflation

The future evolution of global energy and commodity prices as well as their impact on price and wage inflation in Norway are highly uncertain. The future path of wage growth is also uncertain. Higher inflation may have a more pronounced impact on wage growth than has been the case in the past 20 to 30 years and than assumed in the Bank’s projections. Should wage growth prove to be higher than assumed, this could in turn lead to higher inflation. There is also a risk that labour shortages could lead to higher wage growth than currently envisaged. On the other hand, business profitability may be weaker ahead than assumed, which could in turn restrain wage growth.

4 Monetary policy analysis

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.75% to 1.25% at its meeting on 22 June. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further to 1.50% in August. The policy rate forecast indicates a further rate rise to around 3% in the period to summer 2023.

The forecast implies a tighter monetary policy stance than in the March 2022 Monetary Policy Report. Prospects for a more prolonged period of high inflation suggest a faster rate rise than in the March Report.

The forecasts are uncertain. If the outlook or the Committee’s assessment of economic relationships changes, the policy rate forecast will also be adjusted.

4.1 Objectives and recent developments

Low and stable inflation

The primary objective of monetary policy is low and stable inflation. The operational target is annual consumer price inflation of 2%. Between the introduction of the inflation target in 2001 and March 2018, the target was 2.5%. A moving average of annual consumer price inflation has been close to 2% since 2001 (Chart 4.1).

Chart 4.1 Average inflation close to the 2% target1

Consumer price index (CPI). Four-quarter change. Percent

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 monetary policy strategy is discussed further in "Norges Bank’s monetary policy strategy".

Somewhat less expansionary monetary policy

Between spring 2020 and autumn 2021, the policy rate was 0%. Between September 2021 and March 2022, it was raised to 0.75% in three steps. The low policy rate in recent years has resulted in a very low money market rate, both in nominal and real terms (Chart 4.2).

Chart 4.2 Lower real interest rate2

Three-month money market rate and real interest rate. Percent

To assess the degree of monetary accommodation, the interest rate level is compared with what is estimated to be a neutral level. The neutral rate of interest is the rate consistent with balanced developments in the economy in the medium term, and the monetary policy stance is assumed to be expansionary as long as the rate is below its neutral level. Both nominal and real interest rates have implications for the tightness of monetary policy. The neutral real money market rate is estimated to range between -0.5% and 0.5% (see "Estimates of the neutral real interest rate"). The forecasts in this Report are based on the assumption that the neutral rate lies in the middle of this range. With inflation expectations anchored close to the inflation target and a money market premium of 0.35 percentage point, the estimate of the neutral real interest rate implies that the neutral policy rate is around 1.7%.

Developments in the real interest rate adjusted for CPI-ATE inflation suggest that monetary policy has gradually become less expansionary since the second half of 2020 (Chart 4.2). Since the March Report, the real interest rate has edged down. This is primarily attributable to higher underlying inflation, while the money market rate is broadly unchanged since March.

4.2 New information and new assessments

Model-based interpretation of new information

To shed light on how new information influences the economic outlook, new information and assessments are incorporated into the modelling system, while conditioning on the policy rate path in the March Report. In this exercise, the main focus is on the outlook for capacity utilisation and inflation, two important considerations to which the Committee gives weight in the conduct of monetary policy.

Capacity utilisation in the Norwegian economy is assessed as being higher than assumed in the March Report. This must be seen in the context of a tighter labour market than expected. The output gap conditioned on an unchanged policy rate path will remain higher throughout the projection period than projected in March (Chart 4.3). This reflects a lower real interest rate, on account of higher price and wage inflation, which will stimulate demand and amplify pressures in the Norwegian economy if monetary policy does not respond.

Chart 4.3 Higher capacity utilisation3

Estimated output gap. Conditioned on new information concerning economic developments and the policy rate forecast in MPR 1/22. Percent

CPI-ATE inflation has moved up recently and is expected to rise for a period ahead. The wage growth forecasts for 2022 and 2023 have been revised up on the back of growing labour shortages. This pulls up domestic inflation throughout the projection period. Imported inflation has risen more than expected, and in the period ahead, higher global inflation and a weaker-than-expected krone will pull up imported inflation further. Conditioned on an unchanged policy rate path, the inflation projections have been revised up substantially compared with the projections in the March Report (Chart 4.4).

Chart 4.4 Prospects for higher inflation4

CPI-ATE. Projections conditioned on new information concerning economic developments and the policy rate forecast in MPR 1/22. Four-quarter change. Percent

The model exercise indicates a need for a tighter monetary policy than envisaged in March. This will restrain inflation so that it comes down faster towards the target than in the model exercise.

A simple rule implies a higher policy rate

A simple estimated rule based on Norges Bank’s previous policy rate setting summarises the historical pattern of monetary policy reaction.5 Using the change in the capacity utilisation and inflation projections provides an indication of how monetary policy has previously reacted to similar news.

Owing to the upward adjustment of the inflation and output gap projections, the simple rule now implies a higher policy rate in the near term than implied by the rule with the projections in the March Report (Chart 4.5).

Chart 4.5 Simple rule implies a higher policy rate6

Percent

Forward rates indicate a higher policy rate path

Forward money market rates and bond yields can provide an indication of expectations of future policy rate changes. Changes in market rates can indicate how market participants interpret new information and how they believe Norges Bank will respond. Even though forward rates can be volatile, they can function as a cross-check of whether monetary policy is consistent with Norges Bank’s previous forward guidance and response pattern.

Estimated forward rates are higher than in March for the entire projection period (Chart 4.6). Developments in forward rates since the March Report suggest that the market interprets the sum of new information as an indication of higher interest rates ahead. The rise in forward rates this year and next is somewhat smaller than the upward adjustment of the policy rate path since the March Report.

Chart 4.6 Estimated forward rates have risen7

Percent

Policy rate to be raised further

The policy rate path has been revised up since the March Report, and the forecasts indicate that the policy rate rises to around 3% in the period to summer 2023 (Chart 4.7). The policy rate path flattens thereafter, before moving down a little towards the end of the forecast horizon.

Chart 4.7 Towards a contractionary monetary stance8

Percent

Higher capacity utilisation, rising wage growth and stronger external inflationary impulses will push up inflation ahead. This suggests that a tighter monetary policy is now required to contain the rise in inflation and help bring it back down towards target. With higher interest rates in the coming years, capacity utilisation will decline towards a more normal level. Inflation is nevertheless above target and capacity utilisation higher than normal at the end of the forecast horizon (see "Forecasts beyond the forecast horizon").

Both nominal and real interest rates have implications for how monetary policy affects the Norwegian economy. Without a rate hike now, the policy rate would have remained below a neutral rate. The updated policy rate path implies that the policy rate moves towards a neutral rate by autumn and continues to rise thereafter. This means that the monetary stance will be contractionary from the end of the year and over the remainder of the projection period. In terms of the real interest rate, the monetary stance turns contractionary at the beginning of next year and remain contractionary over the remainder of the projection period. The policy rate path has been adjusted up over the entire horizon. Because the inflation projections have also been adjusted up, the projected real interest rate rises less than the policy rate path. Nevertheless, the real interest rate is projected to be higher than in the March Report over the latter part of the forecast horizon.

The policy rate path is the Bank’s forecast of the policy rate for the coming years and expresses the Committee’s trade-off between monetary policy objectives. If the economic outlook, the balance of risks or the assessment of the functioning of the economy changes, the policy rate may prove to be different from the one now indicated by the policy rate path. The fact that the estimate of the neutral interest rate is uncertain adds to the uncertainty surrounding the policy rate forecast.

3 Period: 2016 Q1 – 2025 Q4. The output gap measures the percentage deviation between mainland GDP and projected potential mainland GDP.

4 Period: 2016 Q1 – 2025 Q4. Projections from 2022 Q1 for MPR 1/22 and from 2022 Q2 for MPR 2/22. CPI-ATE: CPI adjusted for tax changes and excluding energy products.

5 The rule has been updated since the March Report in order to obtain a better fit for the historical covariance between the money market rate, inflation and the output gap. It is estimated based on data for the period 2009 Q1 – 2021 Q4 and is expressed as follows: i_t = 0,8i_t–1 + 0,2

+ 0,3

_t + 0,2 ŷ_t, where i_t is the three-month money market rate (Nibor),

is the implied five-year rate five years ahead,

_t is the SAM forecast of CPI-ATE inflation as a deviation from the inflation target and ŷ_t is the output gap.

6 Period: 2016 Q1 – 2022 Q4. Projections from 2022 Q1 for MPR 1/22 and 2022 Q2 for MPR 2/22.

7 Period: 2016 Q1 – 2025 Q4. Projections from 2022 Q1 for MPR 1/22 and 25 March. Projections from 2022 Q2 for PPR 2/22 and 17 June. Expectations since MPR 1/22. Policy rate expectations include variability in the period 13 June to 17 June.

8 Period: 2016 Q1 – 2025 Q4. Projections from 2021 Q4 for MPR 1/22 and 2022 Q1 for MPR 2/22 for the real interest rate calculated with the CPI-ATE. Projections from 2022 Q1 for MPR 1/22 and 2022 Q2 for MPR 2/22 for the policy rate and money market rate.

4.3 Decomposition of changes in the rate path

The decomposition shown in Chart 4.8 illustrates the main drivers behind the change in the rate path from the March Report. The bars show contributions to changes in the rate path based on our main model NEMO, and the broken black line shows the sum of the bars. The solid line shows the actual change in the rate path.

Chart 4.8 A number of factors pull up the rate path9

Cumulative contribution. Percentage points

Capacity utilisation is projected to be higher than in the March Report, as potential output is assessed as being somewhat lower. The high level of capacity utilisation is adding to price and wage pressures and therefore suggests a higher policy rate at the beginning of the period. Further out, capacity utilisation is pulled down by somewhat lower-than-projected public demand. On the other hand, the projected residential mortgage rate is revised up less than the policy rate path, reflecting a slower normalisation of deposit margins than previously assumed. This pulls down the rate path less than would otherwise have been the case. Factors relating to potential output and domestic demand pull up the rate path a little at the beginning and pull it down further out (dark blue bars).

Underlying inflation has been higher than projected in the March Report and is expected to rise further in the coming period. The wage growth projections for 2022 have been revised up, reflecting stronger labour market pressures. In addition, higher energy prices push up both wage growth and underlying inflation in 2023 to a further extent than projected earlier. On balance, price and wage inflation will be somewhat higher than can be explained by the modelling system based on output gap developments and other driving forces in the model. Prices and wages therefore pull up the rate path throughout the projection period (purple bars).

Oil and gas futures prices are higher than in the March Report. This contributes to somewhat higher activity in petroleum-related industries, and the projections for petroleum investment have been revised up towards the end of the projection period. Petroleum prices and investment therefore pull up the rate path (beige bars).

The krone is weaker than projected in the March Report. Higher petroleum prices in isolation suggest a stronger krone, while a considerabely lower interest rate differential against other countries points in the opposite direction. According to the modelling system, the exchange rate has depreciated more than implied by developments in petroleum prices and the interest rate differential against other countries. Developments in the krone exchange rate therefore pull up the rate path (orange bars).

Higher inflation prospects among Norway’s trading partners have led to a rise in policy rate expectations. This suggests in isolation a weaker krone, which in turn may push up inflation and net exports, and therefore pulls up the rate path. The rate path is also pulled up by higher global inflation, which pushes up prices for imported goods and contributes to higher inflation in Norway. The sum of the contributions from foreign interest rates and external inflation are shown by the green bars.

The rate path is curbed by expected weaker growth among trading partners ahead (red bars).

Factors relating to the assessment of price and wage inflation, the krone exchange rate and foreign interest rates and oil and gas prices pull up the rate path. Lower public demand and lower growth among trading partners pull the adjusted path down a little. On balance, the model-based analysis implies a higher rate path throughout the projection period.

The decomposition shows the contributions to the change in the policy rate path as interpreted by the modelling system. The change in the model-based path, which is the sum of the contributions, will normally deviate somewhat from the change in the projected policy rate path, which is intended to express the Committee’s trade-offs between monetary policy objectives. In this Report, the policy rate path is adjusted up approximately to the same extent as the model-based path.

5 Decision basis for the countercyclical capital buffer

Norges Bank’s Monetary Policy and Financial Stability Committee has decided to keep the countercyclical capital buffer rate at 2.5%.

Creditworthy firms and households appear to have ample access to credit. Credit growth and property price inflation slowed in the course of 2021 after having been high during the pandemic. In 2022, house price inflation has moved up again but is expected to moderate ahead. Commercial property price inflation has also moved up recently, but commercial property prices are expected to edge down ahead on the back of gradually rising yields. On the whole, the assessment of cyclical vulnerabilities is approximately the same as before the pandemic.

Uncertainty about the outlook for global growth and inflation has recently resulted in considerable financial market volatility. An abrupt rise in foreign risk premiums and a sharp fall in asset prices may also affect the Norwegian financial system. Because they are solvent, liquid and highly profitable, Norwegian banks are resilient to shocks. Banks are well equipped to meet the current countercyclical capital buffer requirement while maintaining credit supply.

5.1 Access to credit

Creditworthy firms and households appear to have ample access to credit. Banks have sufficient capacity to meet credit demand. The banks included in Norges Bank’s April Survey of Bank Lending reported unchanged credit standards for households and firms in 2022 Q1 and expected no changes in Q2.

Bond market risk premiums on new issues have increased so far in 2022 (Chart 5.1), with the most pronounced rise for commercial real estate (CRE) firms. Risk premiums are now above the average for the past 10 years, but clearly lower than at the time of the Covid-19 outbreak in March 2020.

Chart 5.1 Bond market risk premium has risen1

Investment grade. Five-year maturity. Basis points over three-month Nibor

5.2 Cyclical vulnerabilities in the financial system

Experience shows that economic downturns are usually amplified following a period of sharp rises in credit and asset prices, which are typical measures of cyclical vulnerabilities. On the whole, the assessment of cyclical vulnerabilities in the financial system is approximately the same as before the pandemic. A broad set of indicators of cyclical vulnerabilities are now at a medium level relative to the indicators’ historical distribution, whereas the indicators signalled high cyclical vulnerabilities prior to the financial crisis (Chart 5.2). The projections for, inter alia, credit, and residential and commercial property prices in the June 2022 Monetary Policy Report suggest that most of the indicators will decline somewhat ahead.

Chart 5.2 Indicators of cyclical vulnerabilities are at a medium level2

Indicators of cyclical vulnerabilities (normalised) on the horizontal scale and 5th percentile projections for GDP growth on the vertical scale

Rising household interest burdens

In recent quarters, household credit growth has moved down gradually, in line with more moderate housing market developments and has been a little slower in recent months than projected in the March Report. Credit growth is expected to continue to decline gradually throughout the projection period on the back of higher lending rates and moderating house price inflation (Chart 5.3 and Annex Table 3).

Chart 5.3 Lower credit growth ahead3

Four-quarter change. Percent

Households’ interest payments are expected to rise more than income ahead (Chart 5.4). The interest burden, ie interest payments as a percentage of after-tax income, is projected to approximately double in the period between 2022 Q1 and 2025. This reflects higher lending rates and a high level of household debt. Household debt-to-income (DTI) ratios have risen substantially over a long period. High income growth, especially in the form of increased equity dividends, contributed to the decline in DTI ratios towards the end of 2021. DTI ratios are expected to edge up in the coming years, before falling a little towards the end of the projection period as credit growth slows.

Chart 5.4 Household interest burden expected to rise4

Percent

Saving during the pandemic was substantially higher than normal. This has increased households’ financial buffers, better equipping them to face higher payments.

Growth in corporate credit from domestic sources has been higher than projected in the March Report and was lifted in particular by higher bank lending growth and was broadly based across sectors. Developments in corporate credit growth are closely tied to developments in business investment. In line with investment projections (see further discussion in Section 3), corporate credit growth is expected to remain elevated in the coming year before declining in the somewhat longer term. The projections for 2023 have been revised up somewhat since the March Report.

Prospects for lower house price inflation

After several years of rapid house price inflation, where prices rose faster than household income, house price inflation over the few years prior to the Covid-19 outbreak was at a stable and moderate level (Chart 5.5). During the pandemic, house price inflation picked up markedly. The rise in house prices slowed through 2021 but has moved up again in 2022 and been higher than projected. A strong labour market has likely kept demand for housing high. At the same time, the inventory of unsold existing homes have been significantly lower than normal (Chart 5.6). The rapid rise in house prices also reflects new regulation on the sale of real property, which has caused temporary bottlenecks in the market for existing homes.

Chart 5.5 Higher house price inflation so far in 20225

Percent

Chart 5.6 Few unsold units in the market for existing homes6

Thousands of existing homes

Sales of new flats have been high so far in 2022 and have helped to hold up new home sales (Chart 5.7). On the other hand, sales of new detached and small dwellings have been lower than the average for recent years, after having fallen to a historically low level in 2021. The low sales of new detached and small dwellings reflect a substantial rise through 2021 in prices for timber, which is an important factor input in the construction of such dwellings. Steel prices have increased markedly, which may affect the construction of flats. The sharp rise in prices for both timber and steel is expected to be temporary. Global prices for these commodities have fallen, and futures prices suggest a further decline. Housing construction is expected to be constrained by high construction costs and labour shortages ahead (see also Section 3). The projections are uncertain, reflecting uncertainty regarding prices for and deliveries of building materials and the supply of labour.

Chart 5.7 High level of new home sales in 20227

Turnover. In hundereds of new homes

House prices are projected to fall slightly in the coming year in response to higher lending rates (Chart 5.8). House price inflation is expected to pick up again somewhat further out in the projection period. Overall, the house price projections have been revised up slightly since the March Report. Higher lending rates are having a dampening effect, but house price inflation is being sustained by a tight labour market, with low unemployment and high wage growth. Following a period of very low interest rates and high household debt ratios, there is heightened uncertainty regarding households’ response to higher interest rates. The housing market slowdown may be more pronounced than previously assumed.

Chart 5.8 Lower house price inflation ahead8

Four-quarter change. Percent

Prospects for lower CRE selling prices

CRE selling prices have risen sharply over a number of years (Chart 5.9). Prices fell at the beginning of the pandemic but have since picked up again. Selling prices are estimated as rental prices divided by a yield. The rise in selling prices since mid-2021 reflects markedly higher rents. Owing to the low supply of new office buildings, high employment growth and strong economic growth, rents are also expected to rise rapidly in the period ahead. In the longer term, the rise in rents is expected to be moderate, in line with increased construction activity and slower growth in the Norwegian economy.

Chart 5.9 Commercial property prices are expected to decline somewhat9

Estimated selling prices. In thousands of NOK per square metre

The yield depends on developments in long-term interest rates and risk premiums. The spread between long-term interest rates and observed yields has narrowed in Oslo and other European cities over the past six months (Chart 5.10). In 2022 Q1, the spread in Oslo was at its narrowest since before the financial crisis. Long-term interest rates rose further in Q2, and a gradual rise in the yield is therefore expected ahead. Overall, the projections for rents and yields indicate that CRE selling prices will decline somewhat ahead (Chart 5.9).

Chart 5.10 The spread between yields and long-term interest rates has narrowed in a number of European cities10

Yield less the five-year swap rate. Percentage points

A new analysis by Norges Bank indicates that banks are broadly exposed to the CRE market (see "Banks are broadly exposed to the commercial real estate market"). A majority of banks’ CRE exposures are in the office segments of cities, particularly Oslo. Retail and industrial buildings and warehouses also account for a substantial share of exposures, while hotels and restaurants account for a far lower share. Banks’ losses on CRE exposures are expected to be low ahead.

Increased risk of shocks

Shocks from different parts of the economy and financial markets can threaten financial stability. Uncertainty about the outlook for global growth and inflation has recently resulted in considerable financial market volatility. The financial system largely operates across borders. An abrupt rise in foreign risk premiums and sharp fall in asset prices may also affect the Norwegian financial system. Owing to financial system vulnerabilities, such shocks may have a more pronounced impact on the Norwegian economy.

Commercial property prices are particularly vulnerable to higher interest rates or risk premiums when yields are low. An abrupt rise in the yield can lead to a more pronounced fall in selling prices. The rise in commercial property prices in recent years has not been matched by corresponding borrowing by CRE firms. As a result, their equity ratios have increased, better equipping them for a price fall.

Some CRE firms may find it difficult to refinance their bond debt if commercial property prices fall markedly, as the Norwegian bond market has become an important source of funding for many CRE firms. CRE firms, particularly those in the high-yield segment, have issued relatively large volumes of bonds that will mature in the coming years.

High household debt can also amplify the impact of shocks to the financial system and the Norwegian economy. Following a period of very low interest rates, low inflation and high household debt ratios, there is heightened uncertainty regarding households’ response to higher interest rates and prices. In addition, high debt ratios make many households vulnerable to a fall in house prices and a loss of income. When shocks occur, many households may need to tighten consumption, particularly those with small financial buffers. A reduction in consumption by a large number of households could reduce firms’ earnings and debt servicing capacity and in turn result in higher bank losses and amplify a downturn in the Norwegian economy. Higher than normal household saving through the pandemic has increased households’ financial buffers, better equipping them to face higher expenses.

5.3 Banks

Norwegian banks are profitable, and their current profitability is their first line of defence against higher losses. Return on equity for the large Norwegian banks increased to 12% in 2022 Q1 (Chart 5.11), primarily due to reduced operating costs and banks’ reversal of earlier loss provisions. Net interest income, which is banks’ most important income source, has increased over the past year owing to higher lending rates. Higher net interest income is expected to contribute to sustaining profitability ahead.

Chart 5.11 Banks are profitable11

Return on equity. Annualised. Percent

Credit losses as a share of gross lending for all Norwegian banks fell close to zero in 2022 Q1 (Chart 5.12), primarily because banks have reversed earlier impairment losses, reflecting better-than-expected economic developments. The levels of banks’ cumulative impairment losses are close to pre-pandemic levels, indicating a limited scope for further reversals among large banks. Credit losses are therefore expected to normalise ahead.

Chart 5.12 Bank credit losses are low12

Credit losses as a share of lending. Annualised. Percent

Norwegian banks are solvent and well equipped to maintain credit supply. Large banks already satisfy the capital requirements effective from March 2023, including a countercyclical capital buffer rate of 2.5% (Chart 5.13). The Common Equity Tier 1 (CET1) capital ratio for the seven large banks in the aggregate fell by 0.8 percentage point in 2022 Q1. The decline primarily reflects DNB’s acquisition of Sbanken, which reduced DNB’s Tier 1 capital ratio by approximately 1.3 percentage points.

Chart 5.13 Banks are well equipped to meet the approved countercyclical capital buffer requirement13

Percent. At 2022 Q1

The banking package, which comprises revised EU capital, recovery and resolution rules, has now been transposed into Norwegian law.14 The package includes, inter alia, amendments that will reduce banks’ capital requirements for lending to small and medium-sized firms, and for infrastructure projects. Finanstilsynet (Financial Supervisory Authority of Norway) has also recently reduced Pillar 2 requirements for three of the large banks. At the same time, Finanstilsynet increased the capital margin requirement, which it expects the banks to satisfy, for four of the banks.

Norwegian banks have ample access to wholesale funding. The risk premiums on senior bonds and covered bonds have increased so far in 2022 and are now somewhat higher than the average for the past 10 years (Chart 5.1). Banks meet the requirements for liquidity reserves and long-term funding by ample margins and are therefore well equipped to weather financial market stress.

Annex

Detailed tables of projections

Table 1 International projections

1 The aggregate includes: Euro area, China, UK, Sweden, US, Brazil, Denmark, India, Poland, South Korea, Singapore, Thailand and Turkey. Export weights.

2 The aggregate includes: China, euro area, Sweden, UK and US. Export weights.

3 The aggregate for underlying inflation includes: Euro area, Sweden, UK and US. Import weights.

4 Projections for compensation per employee in the total economy. The aggregate includes: Euro area, Sweden, UK and US. Import weights.

5 In foreign currency terms. Including composition effects.

Sources: IMF, Refinitiv Datastream and Norges Bank

Table 2a Consumer prices. Twelve-month change. Percent

Sources: Statistics Norway and Norges Bank

Table 2b House prices. Monthly change. Seasonally adjusted. Percent

Sources: Eiendomsverdi, Finn.no, Real Estate Norway and Norges Bank

Table 2d GDP for mainland Norway. Monthly change. Seasonally adjusted. Percent

Sources: Statistics Norway and Norges Bank

Table 2c Registered unemployment (rate). Percent of labour force. Seasonally adjusted

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

Table 2e GDP for mainland Norway. Quarterly change.¹ Seasonally adjusted. Percent

1 Quarterly figures are calculated based on monthly national accounts.

Sources: Statistics Norway and Norges Bank

Table 3 Projections for main economic aggregates

1 All figures are working-day adjusted.

2 Annual figures are calculated based on monthly national accounts.

3 Government Pension Fund Global measured at the beginning of the year.

Sources: Eiendomsverdi, Finn.no, Ministry of Finance, Norwegian Labour and Welfare Administration (NAV), Real Estate Norway, Refinitiv Datastream, Statistics Norway and Norges Bank