The Covid-19 pandemic has led to a sharp downturn in the Norwegian economy. Low interest rates are dampening the downturn and mitigating the risk of a more prolonged impact on output and employment. Since the September 2020 Monetary Policy Report, higher infection rates and stricter containment measures have weighed on activity, but there are prospects for a faster upturn through 2021. There is substantial uncertainty surrounding the economic recovery ahead.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to keep the policy rate unchanged at 0% at the monetary policy meeting on 16 December. There are prospects that the policy rate will remain at the current level for some time ahead.

Rise in infection rates impairs the global recovery

The Covid-19 outbreak led to a severe downturn in the global economy. Activity among Norway’s trading partners picked up considerably through summer and was higher in Q3 than assumed in the September Report. A sharp rise in infection rates and stricter containment measures in many countries are now weighing on economic activity. Vaccine availability will likely speed up the recovery through 2021 compared with that projected in the September Report. High unemployment and low wage growth will likely contribute to keeping global inflation low in the years ahead. Market-implied rates still indicate expectations of very low interest rates among Norway’s trading partners for a long time ahead.

Oil prices have risen since the September Report and are now around USD 50. European gas prices have continued to rise. Futures prices indicate broadly unchanged oil and gas prices in the coming years.

Heightened volatility in the wake of the Covid-19 outbreak subsided through spring and summer. Since the September Report, there have been relatively large movements in financial markets. Positive vaccine news has contributed to a rise in global equity markets. Long-term US interest rates have risen since September, while long-term euro area interest rates have fallen. Bond risk premiums have fallen further both abroad and in Norway. Norwegian money market premiums have risen and have been slightly higher than expected. Residential mortgage rates are little changed since the September Report.

The krone exchange rate, as measured by the import-weighted index I-44, has appreciated after reaching record-weak levels in March. Reduced uncertainty in global financial markets and a rise in oil prices have likely contributed to the krone appreciation. Since the September Report, the krone exchange rate has fluctuated somewhat, but the krone is now stronger than projected in September.

Prospects for a pronounced recovery in 2021

After the Covid-19 outbreak led to a sharp decline in the Norwegian economy in March and April, economic activity has picked up and unemployment has come down from historically high levels. Mainland GDP was 1.5% lower in October than in February. The level was higher than projected in the September Report.

Higher household demand has been the main driver of activity in the mainland economy since spring. Household consumption of goods has picked up markedly, but overall consumption remains low. Since income for most households has remained solid, the saving ratio has risen to a very high level on the back of a long period of limited consumption opportunities. High household saving provides room for strong consumption growth ahead, but it is highly uncertain how quickly and how far the saving ratio will fall.

Through autumn, infection rates have also risen in Norway, and stricter containment measures have been introduced. Household demand is falling, and the economic recovery has stalled. In November, the enterprises in Norges Bank’s Regional Network reported that they expect weak growth in activity ahead.

The number of furloughed workers has risen again. Registered unemployment rose to 4.1% in November, which is higher than projected in the September Report. Long-term unemployment has risen substantially, especially among the youngest age groups. A renewed period of low growth, may entail that it will take longer for those who are now unemployed to return to work.

Housing market activity has picked up further through autumn. Turnover in the housing market has been high, and house prices have risen more than projected. Growth in credit to households has risen a little, in line with the projections in the September Report.

Since the September Report, it has become increasingly likely that one or more vaccines will be made widely available during 2021, which is expected to give a clear boost to economic activity in 2021. There is still uncertainty about the evolution of the pandemic and its economic impact.

Increased infection rates and the reintroduction of containment measures have prompted the Government to propose new economic measures for 2021, which will result in somewhat higher public spending in 2021 than indicated in the National Budget. The approved budget may suggest that petroleum revenue spending in 2021 will turn out slightly lower than assumed in the September Report.

Inflation has moderated

The underlying rise in prices measured by the consumer price index (CPI) adjusted for tax changes and excluding energy products (CPI-ATE) picked up through spring and summer. The rise is primarily attributable to higher imported goods inflation, which in turn reflects the krone depreciation through winter and spring. In recent months, CPI-ATE inflation has moderated and has been lower than projected in the September Report. In November, 12-month CPI-ATE inflation was 2.9%. Norges Bank’s Expectations Survey indicates that inflation expectations in the somewhat longer term are well-anchored around the inflation target.

Lower energy prices contributed to a marked decline in CPI inflation through 2019. Twelve-month CPI inflation picked up through spring and summer, but fell abruptly to 0.7% in November. Futures prices for electricity and fuel have fallen since September and now indicate a somewhat slower rise in energy prices through 2021 than previously assumed. This may contribute to a considerably slower rise in CPI inflation in the coming year than projected in the September Report.

This year’s wage negotiations began in August, and on the basis of negotiations with manufacturing sector trade unions, the wage norm for manufacturing as a whole was estimated at 1.7%. The other wage settlements appear to have been in line with this norm. A marked decline in the number of employees in low-wage sectors in isolation lifts overall annual wage growth somewhat. These compositional effects appear to be more pronounced than assumed earlier, and annual wage growth is now projected at 2.2%.

Low policy rate ahead

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.

The Norwegian economy is in the midst of a deep downturn. Higher infection rates and stricter containment measures are now holding back the recovery. On the other hand, there is positive news about vaccines, and there are prospects that vaccination can begin in the very near future. This may result in a faster pick-up in economic activity than previously projected. Nevertheless, it will probably take time for output and employment to return to pre-pandemic levels.

Underlying inflation is above the target, but the krone appreciation since March and prospects for low wage growth suggest that it will moderate further ahead. As long as capacity utilisation is rising, there is limited risk that inflation will become too low.

In discussing the trade-offs facing monetary policy, the Committee placed weight on the contribution of low interest rates to speeding up the return to more normal output and employment levels. This reduces the risk of unemployment becoming entrenched at a high level. On the other hand, the Committee was also concerned that house prices have risen markedly since spring and that a long period of low interest rates increases the risk of a build-up of financial imbalances.

In the Committee’s assessment, the overall outlook and balance of risks imply a very expansionary monetary policy stance. In spring, the policy rate was reduced by a total of 1.50 percentage points to 0%. The sharp economic downturn and considerable uncertainty surrounding the outlook suggest keeping the policy rate on hold until there are clear signs that economic conditions are normalising. The Committee does not envisage making further policy rate cuts.

The policy rate forecast implies a rate at the current level for over a year ahead, followed by a gradual rise from the first half of 2022 as activity approaches a normal level. The forecast implies a somewhat faster rate rise than projected in the September Report. With such a policy rate path, there are prospects that capacity utilisation will gradually increase and that the output gap will close during the projection period. Unemployment is projected to decline, but remain somewhat higher than prior to the pandemic. Underlying inflation is projected to edge down over the next year and a half, before rising to somewhat above 1.5% towards the end of the projection period.

The Committee decided unanimously to keep the policy rate unchanged at 0%. In the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely remain at today’s level for some time ahead.

 

Øystein Olsen
Ida Wolden Bache
Ingvild Almås
Jeanette Fjære-Lindkjenn

16 December 2020