A lower policy rate cannot prevent the coronavirus outbreak from having a substantial impact on the Norwegian economy, but it could dampen the downturn and mitigate the risk of more persistent effects on output and employment.

Weaker global growth and fall in oil prices

The outbreak of coronavirus (Covid-19) has weakened global growth prospects. GDP among Norway’s trading partners is expected to be substantially lower in 2020 than projected in the December 2019 Monetary Policy Report. There is considerable uncertainty about the scale and duration of the outbreak and the economic consequences of the measures to limit contagion.

Oil and gas prices have fallen sharply since the December Report, mainly because oil consumption has dropped due to the coronavirus outbreak and because Russia and OPEC did not reach agreement on oil production limits. Futures prices have also declined, but indicate that oil prices will edge up in the coming years.

Lower interest rates and weaker krone

There has been substantial financial market volatility lately. A number of central banks have cut policy rates. Forward rates among Norway’s trading partners have fallen sharply and indicate a very low interest rate level in the years ahead. Global equity indexes have fallen sharply in recent weeks and are lower than in December.

Norwegian forward rates have also shown a sharp decline. Risk premiums in the Norwegian money market have risen markedly recently. Risk premiums in the Norwegian bond market have also increased.

The krone has weakened considerably since the December Report and is weaker than projected, partly reflecting the fall in oil prices and heightened uncertainty surrounding the coronavirus outbreak.

Coronavirus and oil price decline dampen activity in the Norwegian economy

After several years of solid growth, the Norwegian economy likely reached the peak of the economic cycle towards the end of 2019. Growth in the mainland economy slowed through autumn 2019. At the beginning of the year, capacity utilisation in the Norwegian economy appeared to be somewhat lower than projected earlier, but still slightly above a normal level.

The spread of coronavirus is depressing activity in the Norwegian economy. When the enterprises in Norges Bank’s Regional Network were interviewed in February, they expected moderate growth ahead. In a phone survey conducted at the beginning of March, more than a third of enterprises reported weaker growth prospects owing to the coronavirus outbreak and anti-contagion measures. Many enterprises were already negatively affected. A marked drop in travel demand and cancellations of events are heavily impacting various sectors. Households are cutting back on consumption and businesses are postponing investment out of fear of further contagion. Layoff notices have increased. In recent days, the measures to limit contagion mean that many people can no longer work normally. The Government has recently announced measures to limit the economic consequences of the outbreak.

As a result of the fall in oil and gas prices, growth prospects have weakened. Lower prices reduce the profitability of the petroleum industry in Norway and worldwide, which in turn influences both investment and exports. Already before the price fall, there were prospects that Norwegian petroleum investment would slow in the years ahead. Large investment projects are nearing completion, at the same time as fewer large projects are planned for the coming years. 

Krone depreciation pushes up inflation

Consumer price inflation moderated through 2019, primarily reflecting a slower rise in electricity prices. In February, the 12-month rise in the consumer price index (CPI) was 0.9%. Adjusted for tax changes and excluding energy products (CPI-ATE), inflation was 2.1%. Underlying inflation has been higher than projected in the December Report.

Labour market tightening in recent years has pushed up wage growth. Combined with a persistently weaker krone, this pushes up inflation. On the other hand, factors such as lower travel demand may push down inflation.

The expectations of the social partners and Norges Bank’s Regional Network contacts indicated in February lower wage growth in 2020 than 2019. Weaker growth prospects due to the coronavirus outbreak and the oil price decline are expected to curb wage growth.

The policy rate is reduced to 1%

The objective of monetary policy is annual consumer price inflation of close to 2% over time. Inflation targeting shall be forward-looking and flexible, so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances.

Underlying inflation is moving higher. In light of the krone depreciation, inflation may be higher than the target for a period. Growth in the mainland economy has slowed, and the coronavirus outbreak and the fall in oil and gas prices will dampen activity further. There are prospects of higher unemployment and lower wage growth.  

There is substantial uncertainty about the duration and consequences of the coronavirus outbreak. In the Committee’s assessment, the outlook for the Norwegian economy and the risk of a pronounced downturn suggest that it is appropriate to reduce the policy rate now.

A lower policy rate cannot prevent the coronavirus outbreak from having a substantial impact on the Norwegian economy, but it could dampen the downturn and mitigate the risk of more persistent effects on output and employment.

The policy rate forecast declines to close to 0.75% in the course of the year, rising somewhat thereafter. The projections are based on information up to and including Wednesday, 11 March. It is assumed that activity in the Norwegian economy will show a sharp decline in the coming quarters due to the coronavirus outbreak. Growth is then projected to pick up somewhat towards the end of 2020 as the measures to limit contagions are scaled back.

The Committee decided unanimously to reduce the policy rate by 0.50 percentage point to 1.00%. The Committee is monitoring developments closely and is prepared to make further rate cuts.   

Øystein Olsen
Jon Nicolaisen
Egil Matsen
Ingvild Almås
Jeanette Strøm Fjære

12 March 2020