Monetary policy assessment

Activity in the Norwegian economy has continued to rise after Covid-19 containment measures were removed in winter. Since the December 2021 Monetary Policy Report, unemployment has fallen to a low level, and price and wage inflation has been higher than expected. The war in Ukraine has created heightened uncertainty about the economic outlook, but there are prospects of a continued upturn in the Norwegian economy. Rising wage growth and imported goods inflation are expected to push up inflation ahead. The objective of stabilising inflation around the target somewhat further out suggests a higher policy rate.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.5% to 0.75% at its meeting on 23 March. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June.

The war in Ukraine creates heightened uncertainty about the outlook for global growth and inflation

Economic activity among Norway’s trading partners has continued to rise. In 2021 Q4, trading-partner GDP growth was a little higher than projected in the December Report. Labour markets have improved, and wage growth is on the rise. The Omicron wave this winter proved to be more short-lived in advanced countries than assumed in the December Report, and most containment measures have been lifted in many countries.

High energy prices, a surge in freight rates and long delivery times have driven up headline consumer price inflation in many countries. Underlying inflation among trading partners has also moved up, and inflation expectations have increased.

Russia’s invasion of Ukraine has led to heightened uncertainty about global economic developments ahead. Prices for many commodities, including oil and gas, have risen since December, and supply chain disruptions may last longer. High inflation, export market disruptions and greater uncertainty among households and firms are expected to weigh on economic growth ahead, especially in Europe. The economic upturn among trading partners is expected to continue, but growth prospects appear to be weaker than projected in the December Report. The projections for global price and wage inflation are higher than in December.

Chart A Sharp rise in oil and gas prices1

USD/barrel

Sources: Refinitiv datastream and Norges Bank

Uncertainty associated with the war in Ukraine has resulted in financial market volatility. Global equity indexes have fallen, and corporate bond risk premiums have risen. Norwegian money market premiums have also moved up. The krone has appreciated more than projected in the December Report, likely reflecting the rise in oil prices.

Global policy rate expectations have increased on the back of higher inflation and higher inflation expectations. Long-term sovereign bond yields have largely tracked policy rate expectations. Norwegian market rates have also increased and indicate expectations of a further rise in the policy rate. Residential mortgage rates have moved up broadly as expected in response to the policy rate hikes in 2021.

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

Policy rates and estimated forward rates in selected countries. Percent

High employment and little spare capacity in the Norwegian economy

Higher infection rates and containment measures led to a dip in activity around the turn of the year, and mainland GDP was lower than projected in the December Report. However, the impact of the most recent infection wave was less pronounced than assumed in December. In mid-February, the Government removed all domestic containment measures, and uncertainty about the further evolution of the pandemic receded.

Chart C Higher infection rates resulted in lower activity around the turn of the year3

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

Information from Norges Bank’s Regional Network and card transaction data both point to a rapid recovery of activity in sectors most affected by containment measures. Recently, employment has also risen substantially. Moreover, a large share of Regional Network contacts reported capacity and production constraints due to labour shortages in February. The strong demand for labour is evidenced in the large number of job vacancies. Seasonally adjusted registered unemployment fell to 2.1% in February, which is lower than projected in the December Report. Capacity constraints are likely to pull down on growth in the Norwegian economy ahead.

Chart D Regional Network enterprises report high capacity utilisation4

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

The war in Ukraine has led to heightened uncertainty about the economic outlook for Norway. High energy prices are generating substantial government revenue and may drive up petroleum investment and energy exports but will also increase expenses facing households and firms. Some firms may also face supply problems and faltering foreign demand. While lower growth in real household disposable income is likely to curb growth in private consumption, there are still prospects for a continued upswing in the Norwegian economy.

Petroleum revenue spending in 2022 is likely to be higher than assumed in the December Report. The increase in spending relates among other things to measures to strengthen military readiness, refugee intake from Ukraine and prolonged government support for households’ electricity bills. The government’s overall budget plans still imply a tighter fiscal policy than in 2021.

House prices rose markedly at the beginning of 2022 and have been higher than projected. The rise is likely related to the new regulation on the sale of real property, effective from the beginning of this year, in addition to strong housing demand and the low supply of homes for sale. The impact of the new regulation is likely to be transitory, and house price inflation is expected to move down ahead.

Expectations of higher price and wage inflation

High energy prices have driven up the level of overall CPI. Following a rise towards the end of 2022, 12-month CPI inflation has slowed again and was 3.7% in February. Government support to compensate for the surge in electricity prices has pulled down energy price inflation more than expected, but CPI inflation has still been higher than projected in the December Report.

The rise in the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE) has picked up from the low levels in autumn. The rise in prices for both imported goods and domestically produced goods and services has increased. In February, 12-month CPI-ATE inflation was 2.1%, which was higher than projected in December. Other indicators of underlying inflation have also risen and are overall higher than the rate of increase in the CPI-ATE. Inflation expectations have risen, especially at the one- to two-year horizon. Longer-term inflation expectations are somewhat above 2%.

Wage growth in 2021 turned out to be higher than projected in the December Report. At the same time, wage expectations for 2022 have risen, probably reflecting increased labour demand and high consumer price inflation. Annual wage growth in 2022 is now projected at 3.7%, which is higher than in the December Report.

Chart E Rapid rise in underlying inflation5

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 has continued to rise after containment measures were lifted in winter. Employment has increased further, and capacity utilisation appears to be above a normal level. The war in Ukraine has led to heightened uncertainty about the economic outlook, but there are still prospects for a continued upswing in the Norwegian economy. Price and wage inflation has been higher than projected, and wage expectations have risen. Rising wage growth and imported goods inflation are expected to push up underlying inflation ahead.

Monetary policy is expansionary. In the Committee’s assessment, the objective of stabilising inflation around the target somewhat further out suggests a higher policy rate. Higher interest rates will ease the pressures in the Norwegian economy, but employment will likely remain elevated. Uncertainties relating to the economic outlook and households’ response to higher interest rates warrant a gradual rise in the policy rate.

The policy rate forecast has been revised up from the December Report and indicates a rise in the policy rate to around 2.5% at the end of 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 move close to target somewhat further out. Capacity utilisation remains above a normal level in the projection period, and unemployment remains 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 prospect that the war in Ukraine could result in weaker-than-expected global growth amid rising inflation. The Committee was also concerned with the risk of accelerating price and wage inflation as a result of capacity constraints in the economy and persistent global price pressures. If there are prospects of persistently high inflation, the policy rate may be raised more quickly.

The Committee decided unanimously to raise the policy rate to 0.75%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June.

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

23 March 2022

Assessment of the countercyclical capital buffer requirement

At its meeting on 23 March, Norges Bank’s Monetary Policy and Financial Stability Committee decided to increase the countercyclical capital buffer rate to 2.5%, effective from 31 March 2023.

Norges Bank sets the countercyclical capital buffer rate four times a year. The decision and assessment are presented in this Report. 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 is described in Norges Bank Papers 4/2019.

The objective of the countercyclical capital buffer is to bolster banks’ resilience and mitigate the amplifying effects of bank lending during downturns. Banks should build and hold a countercyclical buffer when financial imbalances are building up or have built up. In the event of an economic downturn that causes or could cause higher credit losses and a marked reduction in access to credit, the buffer rate should be lowered with a view to increasing banks’ lending capacity.

The countercyclical capital buffer rate was reduced from 2.5% to 1.0% in March 2020. The buffer rate was raised to 1.5% in June 2021 and to 2.0% in December 2021, effective from 30 June 2022 and 31 December 2022, respectively.

Prior to the reduction in March 2020, the countercyclical capital buffer rate had been set at 2.5%. Financial imbalances had then built up over a long period. During the pandemic, residential and commercial property prices have increased substantially, and household credit growth has accelerated. Since mid-2021, property price inflation has been more moderate, partly owing to higher lending rates. In 2022, house price inflation has been higher than anticipated, but is expected to slow ahead. It is the Committee’s assessment that financial imbalances suggest that the buffer rate should be returned to 2.5%.

Activity in the Norwegian economy has continued to rise after containment measures were removed in winter. The war in Ukraine has led to heightened uncertainty about the economic outlook, but there are prospects for a continued upturn in the Norwegian economy.

Creditworthy firms and households appear to have ample access to credit. Norwegian banks are profitable and their credit losses are low. There appears to be little direct risk of credit losses owing to the war. High oil and gas prices reduce banks’ risk of losses on oil-related exposures. Looking ahead, credit losses are expected to be low. Banks are well equipped to meet a higher countercyclical capital buffer rate while maintaining credit supply.

At its meeting on 23 March, Norges Bank’s Monetary Policy and Financial Stability Committee unanimously decided to raise the countercyclical capital buffer rate to 2.5%, effective from 31 March 2023.

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

23 March 2022

1 The global economy

The rise in economic activity among Norway’s trading partners was slightly stronger than expected in 2021 Q4. Russia’s invasion of Ukraine led to a rise in oil and gas prices and volatility in global financial markets. The projection for trading-partner GDP growth in 2022 has been revised down from the December 2021 Monetary Policy Report. Headline inflation has continued to rise in many countries, and the projections for underlying inflation have been revised up.

The war in Ukraine is weighing on growth

It was assumed in the December Report that higher infection rates owing to the rapid transmission of the Omicron variant would weigh on GDP growth in Q4. Activity rose by over 1.5% in the US and China between Q3 and Q4. Euro area growth was only 0.3% in the same period, and activity has only now regained its pre-pandemic level. Overall, the winter Omicron wave in advanced economies was of shorter duration than envisaged in the December Report, but infection rates have risen to high levels in several Asian countries. In China, very strict containment measures have been introduced in several large cities.

Russia’s invasion of Ukraine has created heightened uncertainty about the economic outlook. Many countries have imposed extensive economic sanctions on Russia, which will likely lead to a severe economic downturn in Russia and reduce its foreign trade. Russia is a major exporter of oil and gas to Europe. Oil and gas prices rose markedly after the invasion, and the rise in prices for a number of commodities has accelerated (Chart 1.1 and in "Sharp rise in commodity prices". The Bank’s projections for growth and inflation among Norway’s trading partners are based on energy and commodity futures prices.

Chart 1.1 Sharp rise in commodity prices1

Commodity prices. Index. Week 1 2021 = 100

Higher goods prices will reduce household purchasing power, increase firms’ input costs and weigh on economic activity. In addition, tighter financial conditions and greater uncertainty faced by households and firms are likely to dampen both consumption and investment. The projection for GDP growth in 2022 has been revised down since the December Report, particularly for European countries (Chart 1.2).

Chart 1.2 The war in Ukraine is weighing on GDP growth in 20222

GDP for trading partners. Quarterly change. Percent

Recent years’ expansionary monetary and fiscal policies are still making a positive contribution to activity in most countries, but it is assumed that monetary tightening will start in 2022. Higher defence spending 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 is expected to continue, and growth is expected to be lower than in the pre-pandemic years. Trading-partner GDP growth is projected to decline gradually from 3.4% in 2022 to about 2% in 2024 (Annex Table 1). Capacity utilisation among trading partners as a whole is expected to be slightly higher than normal from 2023 and to the end of the projection period. Trading-partner imports are expected to increase by 6% in 2022 and close to 5% in 2023.

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. The 12-month rise in the headline consumer price index (CPI) moved up to close to 8% in the US and close to 6% in the euro area in winter (Chart 1.3). The rise in energy prices made up about half of the 12-month rise in the euro area. Underlying consumer price inflation is at 2.7% in the euro area and 6.4% in the US. In recent months, underlying inflation among all Norway’s main trading partners has been higher than projected in December.

Chart 1.3 High consumer price inflation3

Consumer prices. Twelve-month change. Percent

It is assumed that the rise in business costs related to the increases in energy and other commodity prices will to some extent be passed on to consumer prices for goods and services and thereby push up underlying consumer price inflation. In addition, higher infection rates in Asia and the consequences of the war in Ukraine will likely prolong global supply chain disruptions. Global goods price inflation is expected to remain high for longer than assumed in the December Report.

Wage growth among trading partners has been higher than expected in the December Report. Financial support schemes contributed to a rapid rebound in labour demand in many countries after a marked fall at the beginning of the pandemic. At the same time, there have been labour supply constraints, particularly in the US, and job vacancies are very high in many countries. In addition, minimum wages in the EU will likely increase in 2022, and higher consumer price inflation may result in higher wage demands in many countries. Wage growth among Norway’s trading partners is expected to remain above the levels for the pre-pandemic years throughout the projection period. The projections have been revised up since the December Report.

Market-based inflation expectations have continued to rise since December and indicate expectations of high inflation in the coming years. The rise has been particularly pronounced in the euro area. Long-term inflation expectations have also increased and are now slightly above the target levels both for the US and the euro area (Chart 1.4). Underlying consumer price inflation in the US is expected to rise to over 5% in 2022 before gradually falling towards 2.5%. Inflation is also projected to increase markedly in the euro area, Sweden and the UK between 2021 and 2022. The projection for trading partners overall in 2022 has been revised up considerably since the December Report.

Chart 1.4 Higher inflation expectations4

Long-term market-based inflation expectations. Five-year five years ahead. Percent

Producer price inflation for consumer goods imported to Norway (IPK index), in foreign currency terms, has been higher than expected. Food prices in particular have risen sharply in recent months. The war in Ukraine will likely contribute to a sustained rise in food prices. The projections for 2022 and 2023 have been revised up considerably since the December Report (Annex Table 1). With low price inflation for clothing and footwear and for audio-visual equipment in China, inflation measured by the IPK is far lower than overall producer price inflation in major advanced economies.

Higher policy rate expectations abroad

Russia’s invasion of Ukraine has led to heightened uncertainty and volatility in global financial markets. European and US equity indexes have fallen since December (Chart 1.5), and corporate bond risk premiums have edged up. Money market risk premiums have also moved up in recent weeks. The invasion has had a more pronounced impact on markets in Europe than in the US, partly reflecting European companies’ greater direct exposure to Russia and Ukraine.

Chart 1.5 Equity indexes have fallen5

Equity indexes in selected countries. 2 January 2019 = 100

Policy rate expectations among Norway’s main trading partners are appreciably higher than at the time of the December Report. Owing to prospects for continued high inflation, more frequent policy rate increases are expected ahead than previously assumed. The Bank of England and the US Federal Reserve have raised their policy rates by 0.65 and 0.25 percentage point, respectively, since December. The ECB’s policy rates have remained unchanged. Long-term government bond yields have risen since December, driven by higher policy rate expectations.

Uncertainty about the economic implications of the war in Ukraine

Uncertainty about the global economic outlook has increased considerably with Russia’s invasion of Ukraine. It is uncertain both to what extent and for how long the war in Ukraine will affect growth and inflation among Norway’s trading partners. In addition to the humanitarian catastrophe for Ukraine and the neighbouring region, the war may result in persistent disruptions in energy and commodity markets. There is also a risk of a more substantial effect on financial markets and on household consumption and business investment than currently envisaged. Economic growth may turn out lower than projected amid higher-than-expected inflation. In addition, uncertainty remains about the scale and duration of the pandemic-related supply and demand conditions and the implications for global growth and inflation.

2 Financial conditions

Banks have raised their interest rates on residential mortgage loans since the policy rate was raised in the second half of 2021. At the same time, corporate funding costs have increased. In the years ahead, a higher policy rate is expected to lead to a further rise in lending rates.

The surge in oil prices as a result of Russia’s invasion of Ukraine has contributed to an appreciation of the krone since the December 2021 Monetary Policy Report, but lower risk appetite in financial markets is likely to have curbed the appreciation of the currency. Looking ahead, the krone is projected to show little change through the projection period.

2.1 Interest rates

Higher residential mortgage rates

Household borrowing costs have risen since the policy rate was raised in 2021. After the December monetary policy meeting, the largest banks announced their intention to increase residential mortgage rates by up to 0.25 percentage point, but quoted rates have increased slightly less on average.

The rate increases were announced six weeks ahead and thereby took effect in the course of January and February. In January, the average residential mortgage rate was about 2.1% (Chart 2.1), ie 0.3 percentage point higher than before the policy rate hikes in 2021. Developments are broadly in line with the projections in the December Report.

Chart 2.1 Prospects for a steeper rise in lending rates1

Percent

Quoted interest rates on 10-year fixed-rate loans have increased by around 0.4 percentage point to 3.3% since the December Report.

Residential mortgage rates are expected to increase in the years ahead, albeit somewhat less than the policy rate. The average residential mortgage rate is projected to rise to around 4.0% towards the end of the projection period. Deposit rates are expected to rise somewhat less than residential mortgage rates, gradually pushing up margins on deposit-funded lending towards the pre-pandemic level.

Higher interest rate expectations

In the first quarter of 2022, around 80% of households expected deposit and lending rates to increase over the next year, according to Norges Bank’s Expectations Survey. At the same time last year, about a third of households expected higher interest rates.

Market participants also expect a higher interest rate level ahead, and policy rate expectations have risen markedly since the publication of the December Report. Market participants now expect a larger increase in the policy rate than implied by the policy rate path in the December Report, and expectations suggest a policy rate of just below 2.5% at the end of the projection period.

Higher policy rate expectations have also led to a rise in Norwegian long-term interest rates since the December Report (Chart 2.2). Developments in Norwegian interest rates have generally been consistent with developments in international interest rates. The increase in long-term interest rates will result in higher costs for businesses and households seeking fixed interest rates on new financing.

Chart 2.2 Long-term interest rates have increased2

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

Higher money market and risk premiums

The three-month money market rate, Nibor, reflects market policy rate expectations over the next three months and a risk premium, often referred to as the money market premium. Since the December Report, the money market rate has moved up as policy rate expectations have increased and the money market premium has risen.

So far in 2022 Q1, the money market premium has averaged 0.5 percentage point (Chart 2.3). The premium is about 0.15 percentage point higher than in the previous quarter and will likely remain higher than projected in the December Report. The increase reflects expectations of low structural liquidity, and USD funding rates have increased as a result of the war in Ukraine.3 The money market premium is projected to drift down towards 0.35 percentage point in the period ahead.

Chart 2.3 Higher money market premium4

Percentage points

The interest rate on floating-rate bonds is determined by the money market rate plus a risk premium. Since December, risk premiums on new corporate bond issues have edged up, partly reflecting heightened uncertainty as a result of the war in Ukraine. A higher money market rate will have less effect in the near term on firms’ total bond funding costs as around half of the bonds issued in NOK are fixed-rate bonds. The interest rate on banks’ loans to the corporate sector is usually linked to the money market rate. The rise in the money market rate has therefore also led to higher corporate lending rates.

While global equity indexes have fallen, the Oslo Børs Benchmark Index has edged up since the December Report, mainly on account of higher oil and gas prices.

2.2 Krone exchange rate

Stronger krone exchange rate

The krone exchange rate, as measured by the import-weighted exchange rate index I-44, has fluctuated considerably since the December Report, but is now stronger than before the monetary policy meeting in December. This reflects the rise in oil prices since December, particularly after Russia’s invasion of Ukraine. Lower risk appetite in financial markets has likely pulled down on the krone.

The krone exchange rate is projected to show little change over the coming years (Chart 2.4). The future path of the krone exchange rate remains highly uncertain, partly reflecting uncertainty about the war in Ukraine and future developments in commodity and financial markets.

Chart 2.4 Krone exchange rate expected to show little change5

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

3 The Norwegian economy

Activity in the Norwegian economy now appears to be rising rapidly. Unemployment is low and many businesses are experiencing labour shortages. Capacity utilisation appears to be above a normal level. Underlying inflation, as measured by the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE), has risen and was 2.1% in February. Wage growth and wage expectations have also increased.

Strong growth in the mainland economy is expected in 2022, even if the war in Ukraine dampens the upturn somewhat. Capacity constraints and higher interest rates push down growth in the years ahead. Underlying inflation rises further through 2022 on the back of higher wage growth and increases in global prices. Further out in the projection period, lower capacity utilisation curbs price and wage inflation. Consumer price inflation is projected to be slightly above 2% at the end of the projection period.

3.1 Output and demand

Faster upturn than expected

Since the Covid-19 outbreak in spring 2020, activity in the Norwegian economy and the number of unemployed have fluctuated in step with changes in infection rates and the scale of containment measures. Mainland GDP grew by 4.2% in 2021, after falling by 3.0% in 2020. Owing to higher infection rates and stricter containment measures, activity declined slightly in December and January (Chart 3.1).

Chart 3.1 Higher infection rates resulted in lower activity around the turn of the year1

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

In mid-February, the Government removed all domestic containment measures, and the Regional Network enterprises hardest hit by the measures reported a rapid rise in activity after the reopening of society. Card transaction data also point to a marked pick-up in services following the unwinding of containment measures. A drop in unemployment indicates a substantial rise in activity in February.

Economic developments in December and January were slightly weaker than projected in the December Report, but the recent upturn appears to have been stronger than envisaged.

The projections in this Report assume that the pandemic will no longer place any significant constraints on economic activity.

In February, Regional Network contacts expected higher growth in the coming months, with service companies in particular anticipating a sharp upswing (Chart 3.2). The exception is retail companies, who anticipated a fall in activity as they expected households to increasingly rotate spending back to services after the pandemic and greater trade leakage through increased cross-border shopping and foreign travel. A large share of contacts reported production and capacity constraints due to labour shortages (see "Higher level of capacity utilisation" for a further discussion of capacity utilisation).

Chart 3.2 Regional Network contacts expect higher growth2

Reported and expected growth. Annualised. Seasonally adjusted. Percent

Russia’s invasion of Ukraine will likely dampen the economic upswing a little, but growth is still expected to continue. Overall, annual growth in mainland GDP is projected to reach 4.1% in 2022. Over the course of 2022, activity will then be higher than indicated by the Bank’s pre-pandemic projections (Chart 3.3). The main drivers of growth in 2022 are consumption and exports (Chart 3.4).

Chart 3.3 Marked rise in activity3

GDP for mainland Norway. Seasonally adjusted. Index. 2018 Q4 = 100

Chart 3.4 Consumption and exports push up growth in 20224

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

Through the pandemic, expansionary fiscal policy and accommodative monetary policy have made a substantial contribution to sustaining economic activity. In 2022, support for households’ electricity bills and measures relating to the war in Ukraine will push up government spending. The Government’s overall budget proposal nevertheless implies tighter fiscal policy in 2022 than in 2021. Further tightening is expected in 2023, as all pandemic-related support measures are likely to be removed over the course of 2022, with support for electricity bills unwound in early 2023 and the economy running above capacity.

In the projection, tighter fiscal policy, in conjunction with higher interest rates, curbs growth in the Norwegian economy in the years ahead. Capacity constraints also weigh on growth. Annual mainland GDP growth declines to 1.6% in 2023 and slows further to about 1% in 2024 and 2025. Lower consumption growth dampens the upturn, while strong investment growth underpins activity. Compared with the December Report, the projection for mainland GDP growth has been revised up for 2022 and revised down for 2023, while the projection for 2024 is unchanged.

High inflation and higher interest rates dampen consumption growth ahead

Over the past two years, the pandemic has severely limited household consumption opportunities. Infection rates and containment measures have primarily affected spending on services, such as restaurant dining, cultural events and foreign travel. As a result, households have saved more than usual. At the same time, households have spent less on services and more on goods than before the pandemic. The reopening of society through 2021 led to a rise in services consumption, while goods consumption later declined. Household consumption has been broadly in line with the December projections.

The rotation from goods to services is expected to continue in the period to summer, with services consumption reaching pre-pandemic levels in the first half of 2022. Foreign travel is still considerably lower than in the years prior to 2020, and it will likely take some time for it to return to these levels, pointing to relatively high goods consumption also in the near term. Heightened uncertainty on account of the war in Ukraine is also likely to curb foreign spending by Norwegian residents in the period ahead.

Updated figures show that household saving through the pandemic has been lower than assumed but remains substantially higher than normal. The high level of savings provides room to increase consumption more than income growth alone would imply. High inflation and a rising policy rate pull down on real household disposable income (Chart 3.5), while higher wage growth and a projected increase in the number of persons finding work will pull in the opposite direction. Overall, real household disposable income is expected to rise by an annual average of 1.5% in the coming years.

Chart 3.5 Slower growth in real household disposable income5

Real household disposable income. Annual growth. Contribution to annual growth. Percentage points

Slower growth in real household disposable income weighs on consumption growth ahead. Household consumption is projected to rise by 6% in 2022, slowing thereafter to around 1½ % towards the end of the projection period.

The projections for household consumption have been revised down compared with the December Report. This reflects lower-than-expected household saving and prospects for higher interest rates and inflation.

Solid growth in housing investment

After moderate developments through much of 2021, house price inflation was higher during the first two months of 2022. The rise is likely related to the new regulation on the sale of real property from 1 January 2022, in addition to strong housing demand and a low supply of homes for sale. House price inflation is projected to move down through 2022 and into 2023 as interest rates rise and the effects of the new regulation on house prices fade. See Section 5 for a further discussion of housing market developments.

Housing investment fell after summer 2021 but picked up towards the end of the year. Developments have been stronger than expected and may suggest that high construction costs through 2021 have had a smaller impact on housing investment than assumed. A large number of Regional Network contacts in the construction industry report labour shortages, which will likely dampen residential construction activity somewhat. Housing investment is nevertheless expected to grow at a solid pace in 2022, while slowing further out as a result of lower house price inflation and higher interest rates.

High business investment

Mainland business investment fell markedly after the Covid-19 outbreak in 2020 but has since recovered. Business investment has been higher than projected in the December Report.

Statistics Norway’s investment intentions survey for 2022 Q1 indicates that power sector investment will fall sharply in 2022, while manufacturing investment will increase substantially. In February, Regional Network contacts reported that they expected solid investment growth over the next 12 months. However, the recent rise in energy prices and other costs will weaken profitability for a large number of firms, which may lead to lower business investment in 2022 than they have anticipated. The uncertainty created by the war in Ukraine may also restrain the willingness to invest. Overall business investment is projected to increase by close to 5% in 2022.

On the back of high capacity utilisation in the Norwegian economy, business investment is projected to expand in the years ahead (Chart 3.6). Services investment rises, with a marked increase in manufacturing investment owing to the climate and energy transition abroad and in Norway. The transition also leads to a sharp pick-up in power sector investment further out. Higher electricity prices (see Table 1.A in ) and limited energy supply will in isolation dampen manufacturing investment in southern Norway, while boosting investment in power generation and transmission capacity. Higher interest rates will in isolation pull down on investment growth ahead.

Chart 3.6 Higher mainland business investment6

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

The Covid-19 outbreak, lower oil and gas prices and heightened uncertainty contributed to a fall in petroleum investment in 2020 and 2021 (Chart 3.7). The decline was cushioned by the temporary tax changes for oil companies, which were adopted in 2020. The tax changes and a substantial rise in oil and gas prices point towards higher investment in 2022. Petroleum investment is nevertheless expected to continue to fall in 2022 owing to the completion of several large projects. The temporary tax changes give oil companies strong incentives to initiate development projects before the end of 2022, and oil companies have announced that they will launch a number of development projects towards the end of the year. Petroleum investment is therefore expected to increase markedly between 2022 and 2025, reinforced by expectations of high oil and gas prices ahead and prospects for higher European demand for Norwegian gas in the years ahead as a result of the invasion of Ukraine.

Chart 3.7 Higher petroleum investment in the years ahead7

Petroleum investment. Constant 2022 prices. In billions of NOK

Increased travel will boost exports and imports

Mainland exports grew rapidly in 2021 after the sharp contraction in 2020. Exports are expected to grow at broadly the same pace in 2022, mainly driven by a recovery in foreign tourism in Norway and higher global oil and energy investment. Increased activity among Norway’s trading partners also pushes up exports, even though the war in Ukraine dampens the rise. The recent krone appreciation in isolation suggests lower exports ahead.

Import growth is projected to be strong over the coming years. In 2022, the main drivers of import growth are mainland business investment and foreign travel by Norwegian residents. Solid growth in petroleum investment also lifts imports ahead.

Uncertainty is high

Russia’s invasion of Ukraine has led to heightened uncertainty about the economic outlook. Norway’s trade with the two countries is small, but shocks caused by the war are also affecting the Norwegian economy. There is substantial uncertainty associated with electricity and commodity prices. If prices rise more than assumed, for example electricity prices, private consumption may turn out weaker. At the same time, high electricity prices provide substantial government revenue, which may result in higher government transfers than assumed.

The projections are based on the assumption that heightened uncertainty as a result of the war dampen household consumption somewhat and that a number of business investment projects are postponed, but the extent and duration of the effects are uncertain. If the war and sanctions dampen activity among Norway’s trading partners more than projected in this Report, foreign trade may weaken more than expected. On the other hand, the effects of the uncertainty may prove less pronounced and the global recovery stronger than assumed.

The pandemic remains a source of uncertainty regarding the economic outlook. High infection rates now have little constraining effect on economic activity, but if case numbers were to rise beyond health service capacity, measures could be reintroduced that constrain activity. There is also a risk that new virus variants may require containment measures.

It is also uncertain how households will respond to higher interest rates. After a period of very low interest rates and high household debt ratios, there is a risk that the impact of higher interest rates on consumption will be stronger than assumed.

3.2 Labour market

Labour market improves

Labour market conditions have improved substantially over the past year. Employment rose rapidly through the second half of 2021, and the number of employed is now higher than before the pandemic (Chart 3.8). Unemployment has declined and is lower than in February 2020.

Chart 3.8 Higher employment than before the pandemic8

Employment. In thousands

In the second half of 2021, employment rose, particularly in accommodation and food services, owing to the unwinding of a number of containment measures through autumn. In 2021 Q4, employment growth was solid in most sectors. The number of temporary foreign workers in Norway has increased gradually since summer but remains below pre-pandemic levels. In January, overall employment rose further, despite the fall in sectors affected by containment measures.

Through much of 2021, the rise in employment was faster than the decline in unemployment, as more people who had been outside the labour market found work. In 2021 Q4, the employment rate increased to the highest level in more than ten years (Chart 3.9).

Chart 3.9 Growth in labour force9

Employed as a proportion of the population (15–74 years). Seasonally adjusted. Percent

Towards the end of 2021, the spread of the Omicron variant led to heightened uncertainty about labour market developments further ahead. Owing to stricter containment measures and a large number of furlough notices, a substantial short-term rise in unemployment was projected. According to weekly data from the Norwegian Labour and Welfare Administration (NAV), furloughs increased somewhat in the second half of December, but as early as from mid-January, the number of furloughed workers started to fall again. At the end of the month, unemployment was only slightly higher than in December.

Unemployment rose considerably less than projected in the December Report, as containment measures were less extensive and of shorter duration than expected. The Government’s wage support scheme, adopted in December 2021, likely also helped limit the impact of the measures on the labour market. So far, the Norwegian Tax Administration’s data for December indicate moderate use of the wage support scheme. Nevertheless, the scheme may have influenced furlough decisions among a larger number of firms than those who used the scheme in December.

In February, unemployment continued to fall, to around 2.1% of the labour force or 58 200 unemployed adjusted for normal seasonal variations, which is lower than prior to the pandemic and the lowest level since 2008. A large number of furloughed workers returned to work in February, but the number of furloughed workers is still higher than before the pandemic.

Strong demand for labour

Following the reopening of society in autumn 2020, labour demand has risen to a high level. Half of Norges Bank’s Regional Network contacts now report that labour shortages are constraining production, which is higher than in November and the highest share since before the financial crisis. The number of vacancies increased in 2021 to the highest level measured in Statistics Norway’s job vacancy survey, which goes back to 2010 (Chart 3.10). The level held steady through 2021 Q4. According to NAV statistics, the number of new job vacancies continued to rise in January and February 2022.

Chart 3.10 High number of job vacancies10

Job vacancies as a share of all jobs. Percent

Labour shortages probably reflect a number of extraordinary pandemic-related conditions. The rise in the number of new job vacancies has largely been in services, a sector severely affected by containment measures. There are still considerably fewer temporary foreign workers in Norway than at the end of 2019. The increase in job vacancies was strongest in sectors where there are still fewer temporary foreign workers, particularly in construction, but also in hospitality and health and social services. At the same time, there also appears to be a limited supply of labour in other sectors. In February, Regional Network contacts reported labour shortages across a number of different occupational groups.

Through the first part of the pandemic, more employment contracts were terminated and there were fewer new hires than normal (Chart 3.11). Over the past year, the number of new contracts returned to a normal level, while the number of terminated contracts is substantially lower than earlier. The low level in 2021 is partly due to the termination of many employment contracts in 2020, but may also be related to the pandemic, financial support measures and lenient furlough rules. If the number of terminations remains at a low level, labour market efficiency may be reduced making it difficult for employers to recruit the necessary labour.

Chart 3.11 Fewer terminated employment contracts than before the pandemic11

New hires and terminated employment contracts. In thousands

Further improvement in the labour market

Unemployment is expected to continue to decline in the coming months owing in part to the removal of the last containment measures in February and strong labour demand. Unemployment is projected to decline to 1.8% in the course of the year, in pace with a pick-up in economic activity, before rising slightly again towards the end of the projection period.

Employment is projected to rise further in the near term. In February, Regional Network contacts reported continued brisk employment growth in recent months and expectations of a stronger rise in the coming months. In particular service sector contacts expected higher employment growth ahead, but oil service contacts also expected a solid rise in the near term. In the projection, a cyclical peak is reached in the second half of 2022. Employment growth thereby slows towards the end of the year and then remains moderate over the latter part of the projection period. The decline in unemployment to a low level pulls down on employment growth ahead. The war in Ukraine is expected to lead to a rising number of refugees in Norway, some of whom will likely join the Norwegian labour market after a period.

The increase in the number of temporary foreign workers is projected to continue. An introduction of a ban on contract labour in construction in the Oslo fjord area indicates that the number of short-term workers will not fully return to the pre-pandemic levels over the projection period.

The projections for the labour market are uncertain. The supply of foreign labour may not pick up as much as projected. There is also uncertainty about the number of refugees from Ukraine, and how many will transition to employment, and how fast. At the same time, the pandemic remains a source of uncertainty. If any new variants emerge that also require containment measures, unemployment could turn out higher than projected.

Chart 3.12 Unemployment will continue to decline12

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

3.3 Costs and prices

Higher wage growth

The tightening of the labour market through 2021 has driven up wages, with annual wage growth reaching 3.5% in 2021. This was higher than projected in the December Report and appreciably higher than the wage norm (Chart 3.13). A rise in bonuses and irregular wage payments contributed to higher-than-expected wage growth.

Chart 3.13 Higher wage growth than expected13

Annual wage growth. Percent

Wage expectations for 2022 have increased by about ½ percentage point since the December Report. In February, Regional Network contacts expected wage growth of 3.7% in 2022. According to Norges Bank’s Expectations Survey in February, the social partners overall expect wage growth of 4.0% in 2022. High labour demand and low unemployment will likely lead to higher wage growth.

Higher prices for electricity and imported goods are driving up consumer price inflation and point to stronger wage growth. Higher prices for intermediate goods may, however, reduce business profitability, which in isolation may restrain wage growth. The Expectations Survey indicates continued improvement in business profitability ahead, but to a lesser extent than at the time of the December Report (Chart 3.14). It is assumed that government support to compensate for the surge in electricity prices will continue in the period to March 2023. This will dampen the rise in prices faced by households and also pull down on wage growth.

Chart 3.14 Continued improvement in profitability14

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

Many of those who are now joining the workforce are paid at below average wages, which in isolation will pull down on the average wage level somewhat in 2022 (see box below on composition effects on wage growth). Measured wage expectations likely capture to a limited degree that composition effects may pull down wage growth in 2022. Wage growth is projected at 3.7% in 2022.

High capacity utilisation suggests that wage growth will rise ahead. Experience shows that high oil and gas prices boost activity and strengthen mainland business profitability, which in turn may push up wage growth. Wage growth is projected to rise to 4.0% in 2023 (Chart 3.15), slowing a little thereafter as the output gap narrows.

Chart 3.15 Prospects for high wage growth15

Annual wage growth. Percent

Higher inflation

CPI inflation has varied widely as a result of high volatility in electricity prices in recent years. Annual CPI inflation was 1.3% in 2020 and 3.5% in 2021. CPI inflation picked up sharply towards the end of 2021 but has fallen back somewhat in 2022. In February, 12-month CPI inflation was 3.7%, which is slightly higher than projected in the December Report. Government compensation for higher electricity prices has pulled down electricity prices in the CPI from December 2021, and the scale of support turned out to be somewhat larger than assumed in the December projections.

Chart 3.16 Inflation has risen16

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

Underlying inflation has picked up in recent months. The CPI adjusted for tax changes and excluding energy products (CPI-ATE) increased by 2.1% in the year to February 2022, which was higher than projected. Other indicators suggest that underlying inflation is higher, which implies a pick-up in CPI-ATE inflation ahead. The 12-month average rise in indicators of underlying inflation was 2.5% in February (see "Indicators of underlying inflation in Norway").

Imported consumer goods inflation has picked up recently and is higher than projected. The rise partly reflects the sharp rise in international freight rates and imported consumer goods prices (Chart 3.17).

Chart 3.17 Stronger external price impulses17

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

Some of the rise in global prices reflects high demand and pandemic-induced disruptions to global supply chains. The invasion of Ukraine at the end of February has led to a further increase in energy, metal and food prices (see "Sharp rise in commodity prices" for a further discussion). This will also push up domestic inflation (Chart 3.18). Since the December Report, European container freight rates have fallen in line with expectations. Given the war in Ukraine and new lockdowns in China, further normalisation of freight rates may take somewhat longer than expected in December. Imported consumer goods prices have been higher than projected, and the projections have been revised up ahead. Further out, a normalisation of freight rates and commodity prices pulls down imported inflation. In isolation, the recent appreciation of the krone is expected to curb inflation.

Chart 3.18 Prospects for higher inflation18

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

The rise in prices for domestically produced goods and services has also accelerated and been higher than projected, partly owing to higher prices for commodities and other intermediate goods, and pushes up on domestic price inflation somewhat in the near term. As a result of high capacity utilisation and higher wage growth, domestic inflation is expected to pick up over the next couple of years. Overall, CPI-ATE inflation is projected at close to 3% at the end of 2022, before slowing and running just above 2% thereafter.

Electricity prices are expected to remain at historically high levels in the near term, before falling sharply through spring. Government support to compensate for the surge in electricity prices will substantially dampen the effect on the CPI. CPI inflation is projected to rise slightly in the near term and then decline, resulting in annual CPI inflation of 3.4% in 2022. CPI inflation is projected to be lower in 2023, before moving up to just over 2%.

Inflation expectations one and two years ahead, as measured by Norges Bank’s Expectations Survey, have risen recently. In the longer term, inflation expectations are lower, but are somewhat above 2%.

Prospects for higher real wage growth ahead

Wage growth was the same as CPI inflation in 2021, with real wages remaining unchanged. Overall real wage growth is projected to be moderate in 2022, rising to about an annual average of 1¾% in 2023–2025. The relatively large range of variation in wage growth expected over the projection horizon must be seen in the context of composition effects on wage growth this year and large swings in energy prices.

Considerable uncertainty surrounding price and wage inflation

The pandemic and the invasion of Ukraine have resulted in substantial changes in electricity and commodity prices. There is high uncertainty regarding future developments in those prices. The effect on domestic price and wage inflation is also uncertain.

The impact of higher prices on wage growth ahead is also uncertain. The faster rise in inflation may have a stronger impact on wage growth than has been the case in the past 20 to 30 years, and upon which our projections are based. If wage growth were to rise higher, this could in turn lead to higher inflation. There is also a risk that labour shortages may lead to sharply higher wage growth. On the other hand, business profitability may prove weaker ahead than assumed, which could then pull down wage growth.

4 Monetary policy analysis

The policy rate was raised from 0.5% to 0.75% at the Committee meeting on 23 March. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June. The policy rate forecast indicates a gradual rate rise to around 2.5% at the end of 2023.

The forecast implies a tighter monetary policy stance than in the December 2021 Monetary Policy Report. Prospects for higher capacity utilisation and higher price and wage inflation ahead than envisaged earlier suggest a faster rate rise.

The forecasts are uncertain. If the outlook or the Bank’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%. Annual consumer price inflation has over time run 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

In the latter half of 2021, the policy rate was raised to 0.5 in two steps, after having stood at 0% since spring 2020. The low policy rate has resulted in a very low money market rate, both in nominal and real terms (Chart 4.2).

Chart 4.2 Higher real interest rate2

Three-month money market rate and real interest rates. 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 that is 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. With inflation expectations anchored close to the inflation target, the neutral level of the policy rate is estimated at close to 1.7% (see box in Monetary Policy Report 2/21). The neutral real money market rate, ie the money market rate adjusted for inflation, is estimated at close to 0%.

In recent months, the money market rate has moved up. This implies that monetary policy is still expansionary, but somewhat less so than previously. Developments in the real interest rate adjusted for CPI-ATE inflation suggest that monetary policy has gradually become less expansionary over the past year. CPI inflation is being affected by the rapid rise in energy prices. This means that the real interest rate adjusted for CPI inflation has recently been lower than the real interest rate adjusted for CPI-ATE inflation, but it, too, is expected to rise in the period ahead.

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 December 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 December Report. This reflects, among other things, the lower-than-expected economic impact of the most recent infection wave. In the period ahead, a further increase in capacity utilisation is expected, driven in part by strong growth in household consumption and business investment. Growth is restrained by a slight downward revision of growth among trading partners. The output gap projection conditioned on an unchanged policy rate path will be higher than projected in December throughout the projection period (Chart 4.3).

Chart 4.3 Prospects for higher capacity utilisation3

Estimated output gap. Conditioned on new information concerning economic developments and the policy rate forecast in MPR 4/21. Percent

CPI-ATE inflation has edged up recently after having run below 2% through the latter half of 2021. Imported inflation has picked up and has been higher than expected, driven by higher global inflation and high freight rates. Wage growth turned out to be higher than expected in 2021, and the wage growth projections for 2022 have been revised up on the back of growing labour shortages and higher wage expectations. Conditioned on an unchanged policy rate path, the inflation projections have been revised up substantially compared with the projections in the December 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 4/21. Four-quarter change. Percent

The model exercise indicates a need for a tighter monetary policy in order to limit the rise in inflation and help bring inflation down towards target.

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. Using the change in the capacity utilisation and inflation projections provides an indication of how the rate path has previously reacted to similar news (see box in Monetary Policy Report 4/21).

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

Chart 4.5 Simple rule implies a higher policy rate5

Percent

Forward rates indicate a higher policy rate path

Forward money market and bond rates 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 in line with Norges Bank’s previous forward guidance and response pattern.

Estimated forward rates are higher than in December for the entire projection period (Chart 4.6). Developments in forward rates since the December Report suggest that the market interprets the sum of new information as an indication of higher interest rates ahead.

Chart 4.6 Estimated forward rates have risen6

Percent

Policy rate to rise further

At the Committee meeting on 23 March, the policy rate was raised from 0.5% to 0.75%. Moreover, the Committee expects that the policy rate will most likely be raised further in June. In line with the Committee’s assessment, the policy rate path implies a further rise ahead. At the end of 2023, the policy rate is projected to be around 2.5% (Chart 4.7). This is above what is estimated to be a neutral policy rate. At the end of the projection period the policy rate is projected to decline to 2.3%. The policy rate path has been revised up since the December Report.

Chart 4.7 Towards a contractionary monetary stance7

Percent

Higher capacity utilisation, rising wage growth and stronger external price impulses will push up inflation ahead. This suggests that it is now appropriate to raise the policy rate to limit the rise in inflation and help bring inflation back down towards target. Raising the policy rate is also consistent with the simple rule (Chart 4.5) and market expectations (Chart 4.6). Market-based policy rate expectations now lie close to our policy rate forecast over the entire projection horizon. With higher interest rates in the next few years, capacity utilisation will decline towards a normal level.

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 change, the policy rate may prove to be different from the one indicated by the policy rate path.

Both nominal and real interest rates have implications for how monetary policy affects the Norwegian economy. The forecasts for the policy rate and the nominal money market rate imply that monetary policy will be less expansionary, and eventually contractionary. The projected paths of both the nominal and real interest rate suggest that monetary policy will be contractionary from 2023 to the end of the projection period.

The real money market rate is expected to be somewhat lower in the near term than projected in the December Report, since the inflation projections in the coming period have been raised more than the policy rate forecast. Further out, the policy rate path has been raised more than the inflation projections, and the real money market rate is thus projected to be higher than in the December Report through most of the projection period.

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 December 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 path8

Cumulative contribution. Percentage points

Inflation prospects among Norway’s trading partners have led to a rise in policy rate expectations. This suggests in isolation a weaker krone and pulls up the rate path. Higher trading-partner inflation reflects higher energy prices and bottlenecks, among other factors. This pushes up imported inflation, which will pass through to higher domestic inflation. This also pulls up the rate path. On the other hand, the growth projections for trading partners have been revised down a little. On balance, factors relating to external developments imply a higher rate path (green bars).

Underlying inflation has been higher than in the December Report. Wage growth in 2021 turned out to be higher than projected in December, and the wage growth projections for 2022 have been revised up. This will push up inflation ahead. Prices and wages therefore pull up the rate path throughout the projection period (purple bars).

Oil and gas spot and futures prices are sharply higher than in the December Report. This implies a higher rate path. In the current situation, the rise in petroleum prices is expected to have less impact on the Norwegian economy than observed in earlier periods, particularly because investment plans for the coming years have already been scaled up in response to temporary petroleum tax changes. Petroleum investment projections have been revised down for the next years, but later in the projection period, investment is projected to be broadly the same as in the December Report. Nevertheless, overall, petroleum prices and investment pull up the rate path (beige bars).

Higher petroleum prices have contributed to a stronger krone than projected in the December Report. However, according to the modelling system, the krone has appreciated less than developments in petroleum prices and the interest rate differential against trading partners would imply. Developments in the krone exchange rate therefore pull up the rate path slightly (orange bars).

Capacity utilisation is projected to be higher than in the December Report. This is because activity in the Norwegian economy is now higher than assumed in December and because investment demand is expected to pick up faster than anticipated earlier. Factors relating to domestic demand pull up the rate path (dark blue bars).

Margins on household and corporate loans have moved broadly in line with expectations, but the money market premium has risen and is expected to remain higher than assumed in the December Report. A persistently higher money market premium is expected to pass through fully to other market rates further out, pulling down the policy rate correspondingly (red bars).

Factors relating to domestic demand, price and wage inflation, the krone exchange rate, foreign interest rates and oil and gas prices push up the rate path, while a higher money market premium pulls it down a little. On balance, the model-based analysis implies a higher rate path throughout the projection period.

The policy rate forecast reflects the Committee’s monetary policy trade-offs, and the rate path for the coming years has been revised up less than suggested by the model analysis. In its overall assessment of the monetary policy stance, the Committee also takes into account other considerations that are not fully represented in the model analysis. Uncertainties relating to the economic outlook and households’ response to higher interest rates warrant a gradual rise in the policy rate.

5 Decision basis for the countercyclical capital buffer

At its meeting on 23 March, Norges Bank’s Monetary Policy and Financial Stability Committee decided to increase the countercyclical capital buffer rate to 2.5%, effective from 31 March 2023.

Prior to the reduction in March 2020, the countercyclical capital buffer rate had been set at 2.5%. Financial imbalances had then built up over a long period. During the pandemic, residential and commercial property prices have increased substantially, and household credit growth has accelerated. Since mid-2021, property price inflation has been more moderate. In 2022, house price inflation has been higher than anticipated, but is expected to slow ahead. Financial imbalances suggest that the buffer rate should be returned to 2.5%.

Creditworthy firms and households appear to have ample access to credit. Norwegian banks are profitable and their credit losses are low. There appears to be little direct risk of credit losses owing to the war in Ukraine. Banks are well equipped to meet a higher countercyclical capital buffer rate while maintaining credit supply.

5.1 Access to credit

Creditworthy firms appear to have ample access to credit. Banks have sufficient capacity to meet credit demand. Since December, risk premiums on new corporate bond issues have edged up, partly reflecting heightened uncertainty as a result of the war in Ukraine. Recently, higher risk premiums have likely induced some firms to postpone new bond issues. However, there are no signs that creditworthy firms have lost access to the bond market.

Households also appear to have ample access to credit. The banks included in Norges Bank’s Survey of Bank Lending reported unchanged credit standards for households and firms in 2021 Q4, and no changes are expected ahead.

5.2 Financial imbalances

Temporary rise in house price inflation

House prices have risen more than income through the pandemic (Chart 5.1), which has increased housing market vulnerabilities. Since April 2021, the rise in house prices has been more moderate (Chart 5.2). The decline in house price inflation probably reflects higher lending rates and a normalisation of household consumption patterns as society reopens.

Chart 5.1 House prices have risen faster than income through the pandemic1

Index. 1998 Q4 = 100

Chart 5.2 Transitory rise in house price inflation in the beginning of 20222

Percent

In the market for existing homes, demand is still high, and the stock of unsold homes at the beginning of 2022 was low (Chart 5.3). Since the December 2021 Monetary Policy Report, house price inflation has been stronger than projected and should be viewed in the context of the new regulation on the sale of real property, which has likely caused temporary bottlenecks in the real estate market.3 The new regulation includes stricter house survey requirements. House surveys now take longer to prepare, and new surveys must also be prepared for dwellings that have been listed for sale since 2021. This has reduced the number of listings so far in 2022 compared with what is normal (Chart 5.3). In isolation, a reduced stock of homes for sale boosts house price inflation, although this effect is expected to be transitory. It may also be reasonable to assume that the larger a dwelling is, the longer it takes to prepare a house survey. In January, substantially fewer detached and small dwellings (terraced and semi-detached houses) were listed and sold than flats (Chart 5.4). This has likely led to temporary compositional effects on the price index that push up measured house price inflation in the near term because the standard of flats is often higher.

Chart 5.3 Few unsold units in the market for existing homes4

Thousands of existing homes

Chart 5.4 Largest decline in the markets for detached and small dwellings5

Deviation from the mean 2010–2021 by dwelling type. Percent

In the market for new homes, sales of detached and small dwellings fell to historically low levels in the latter half of 2021, while sales of flats remained steady (Chart 5.5). These developments have continued in 2022, although sales of flats have risen to an even higher level. Overall, turnover in the market for new homes has increased since the December Report. The low turnover of new detached and small dwellings reflects a substantial rise through 2021 in timber prices, which are an important factor input in the construction of such dwellings. However, the sharp rise in construction costs has affected housing investment and housing starts to a lesser extent than expected in the December Report. Increased residential construction is expected ahead (see discussion in Section 3).

Chart 5.5 High level of new home sales6

Turnover. Hundreds of new homes

House price inflation is projected to fall through 2022 and into 2023 owing to higher lending rates and because more homes will be listed for sale as the effects of the new regulation dissipate (Charts 5.2 and 5.6). In the somewhat longer term, house price inflation is also expected to decline owing to increased residential construction. Strong labour market developments and real wage growth have the opposite effect.

Chart 5.6 Lower house price inflation ahead7

House prices. Four-quarter change. Percent

Rise in household interest burdens ahead

Over the past six months, household credit growth has moved down a little, in line with more moderate housing market developments, but has been slightly higher than projected in the December Report. Household credit growth is expected to decline gradually ahead owing to higher lending rates and slower house price inflation (Chart 5.7 and Annex Table 3).

Chart 5.7 Lower credit growth ahead8

Credit. Four-quarter change. Percent

Household debt-to-income (DTI) ratios have risen substantially over a long period and are now at a high level (Chart 5.8). Overall, DTI ratios have been relatively stable in 2021. The Bank’s projections for credit and income growth indicate that DTI ratios will rise gradually in the coming years before levelling off towards the end of the projection period.

Chart 5.8 Household interest burden expected to rise9

Percent

With higher lending rates, household interest expenses will rise more than income ahead. The interest burden, ie interest expenses as a percentage of after-tax income, increases gradually from 4.5% in 2021 Q4 to close to 8% towards the end of the projection period (Chart 5.8). At the same time, saving during the pandemic has been substantially higher than normal. This has increased financial buffers in the household sector overall, making it better equipped to face higher interest expenses.

Growth in corporate credit from domestic sources fell through much of 2020 but picked up again through 2021 (Chart 5.7). Developments have been in line with investment growth. In recent months, credit growth has been broadly as projected in the December Report. Low bond market risk premiums contributed to high bond issuance in 2021, which was an important driver of the increase in credit growth. Risk premiums on new bond issues have increased somewhat for most sectors since December, which is expected to dampen credit growth slightly in the near term. Further out, growth in business investment is expected to support credit growth.

Commercial property prices expected to level off

Commercial property selling prices are estimated as rental prices divided by a yield. Selling prices rose markedly in the latter half of 2020 (Chart 5.9), reflecting a substantial fall in the yield. In 2021, prices rose as a result of higher rents.

The yield, which depends on developments in long-term interest rates and a risk premium, has remained stable at a record-low level since 2020 Q4. Long-term interest rates have risen since the December Report (see discussion in Section 2). A gradual rise in the yield is therefore expected ahead. Owing to low supply of new office buildings, high employment growth and strong economic growth, rents are 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. Overall, the projections for rents and yields indicate that commercial property selling prices will level off further out (Chart 5.9).

Chart 5.9 Commercial property prices are leveling off10

Selling prices for commercial property. In thousands of NOK per square metre

Commercial property prices are particularly vulnerable to interest rate increases or higher risk premiums when the yield is low. The war in Ukraine has led to heightened uncertainty about the economic outlook. This may lead to a higher risk premium and a higher yield than previously assumed. However, the rapid rise in commercial property prices in recent years has not been matched by corresponding borrowing by commercial real estate (CRE) firms. This has boosted these firms’ equity ratios, making them better equipped for a price fall. Banks’ losses on CRE exposures are expected to be low ahead.

The pandemic has led to extensive use of remote working. For the time being, there are no signs that this structural change has led to a reduction in demand for office space. For example, market participants point out that a greater need for video conferencing has actually increased demand for office space from some firms with parts of their workforce working remotely.

5.3 Banks

The profitability of large Norwegian banks has been solid over the past year. Return on equity edged lower in 2021 Q4 (Chart 5.10), primarily due to somewhat higher personnel expenses and the marginal increase in the loan loss ratio. Higher deposit margins pushed up net interest income and boosted profitability. Higher net interest income is still expected, owing to higher interest rates in the period ahead.

Chart 5.10 Banks are profitable11

Return on equity. Annualised. Percent

Banks’ credit losses were low in 2021. Credit losses for all Norwegian banks as a whole were approximately 0.1% of gross lending in 2021 (Chart 5.11), primarily because banks have reversed earlier impairment losses, reflecting better-than-expected economic developments.

Chart 5.11 Banks’ credit losses are low12

Credit losses as a share of lending. Annualised. Percent

There appears to be little direct risk of credit losses on account of the war in Ukraine. Norwegian banks’ exposures to Russia and Ukraine are modest. There is also relatively limited trade between Norway and these two countries, which implies that few Norwegian firms will be impacted directly. Moreover, high oil and gas prices reduce banks’ risk of losses on oil-related exposures. Looking ahead, credit losses are expected to reach 0.2%, which is the average for the past 20 years.

The risk premiums Norwegian banks pay for senior bonds and covered bonds have increased somewhat since the December Report. These developments reflect the volatility associated with the war in Ukraine. Nevertheless, banks continue to have ample access to wholesale funding. They meet the requirements for liquidity reserves by an ample margin and are well equipped to weather financial market volatility.

At the end of 2021, the largest banks’ Common Equity Tier 1 (CET1) capital ratios were well above the current capital requirement. The majority of the banks also satisfy the capital requirements applicable from year-end 2022 by ample margins (Chart 5.12). CET1 capital ratios rose by 0.1 percentage point between 2021 Q3 and Q4, and 0.4 percentage in the course of 2021. The rise primarily reflects solid earnings and low credit losses. The large banks’ proposed dividends account for between 50% and 70% of total comprehensive income for 2021, in line with previous projections. Banks’ capital ratios are solid, also when accounting for proposed dividends. Banks are well equipped to meet a higher countercyclical capital buffer rate while maintaining credit supply.

Chart 5.12 Banks are well equipped to meet a higher buffer requirement13

Largest Norwegian-owned banking groups. Percent

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 compositional effects.

Sources: IMF, Refinitiv Datastream and Norges Bank

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

Sources: Statistics Norway and Norges Bank

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

Sources: Quarterly National Accounts from Statistics Norway and Norges Bank

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

Sources: Statistics Norway and Norges Bank

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

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

Table 3 Projections for main economic aggregates

1 All figures are working-day adjusted.

2 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