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 June 2020 Monetary Policy Report, economic activity has picked up broadly as expected, but there is still substantial uncertainty about developments ahead.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to keep the policy rate at 0% at the monetary policy meeting on 23 September. There are prospects that the policy rate will remain at the current level for some time ahead.

Global recovery under way

The Covid-19 pandemic has led to a sharp downturn in the global economy. Activity among Norway’s trading partners is on the rebound and has so far risen somewhat faster than assumed in the June Report. The easing of measures to contain the pandemic through summer has boosted economic activity, while it has also led to increased infection rates. In some countries, registered infection rates are now higher than in spring. Continued high unemployment and prospects for low wage growth will contribute to keeping global inflation low in the years ahead. Market-implied rates still indicate very low interest rates among Norway’s trading partners for a long time ahead.

Oil prices have risen since the June Report and are now above USD 40. Futures prices indicate somewhat higher oil prices in the coming years. European gas prices have increased markedly since June.

The market turbulence in the wake of the Covid-19 outbreak subsided through spring and summer. Since the June Report, money and bond market premiums have fallen further both abroad and in Norway. Norwegian money market rates are at historically low levels. Residential mortgage rates are little changed since June.

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 likely contributed to the krone appreciation. In recent days, market turbulence has increased somewhat and the krone has depreciated. The krone exchange rate is now broadly unchanged from the level prevailing at the time of the June Report.

Activity in the Norwegian economy has picked up

The spread of Covid-19 and measures to contain it contributed to a marked decline in the Norwegian economy in March and April. The decline was amplified by a fall in oil prices and a contraction among Norway’s trading partners. Unemployment reached historically high levels.

In the course of spring, the spread of the virus was brought under control, and economic activity has picked up since May. Nevertheless, mainland GDP was nearly 5% lower in July than in February. Developments were in line with the projections in the June Report. Growth has primarily picked up in the sectors that were directly affected by containment measures, such as hotels and food service, culture, entertainment and other services. In recent months, many of the furloughed employees have returned to work, and unemployment has fallen somewhat faster than expected.

Household demand in particular has given a boost to mainland economic activity. Household consumption of goods has picked up rapidly, but overall consumption is still low.

After summer, infection rates have also risen in Norway, leading to stricter containment measures in some areas, while further relaxation has been put on hold. This may weigh on household demand in the coming months. On the other hand, there appears to be less of a risk of a total lockdown of much of the economy and of a renewed sharp downturn than in June. Several vaccines are in the testing stage, but it is still uncertain when a vaccine can be widely available.

In August, the enterprises in Norges Bank’s Regional Network reported prospects for weak growth in activity ahead. They expected little change in the level of employment in the coming period. Enterprises’ investment plans indicate a sharp fall in investment in the coming year.

Housing market activity has picked up markedly through summer. Turnover in the housing market has been high, and house prices have risen more than projected. Growth in credit to households has also been higher than expected.

Temporary rise in price inflation

The rise in the consumer price index (CPI) has moved higher in recent months after lower energy prices contributed to a marked decline through 2019. In August, 12-month CPI inflation was 1.7%. Futures prices for electricity and fuel indicate a rise in energy prices ahead, which would contribute to a pick-up in CPI inflation in the coming year.

The underlying rise in prices measured by the CPI adjusted for tax changes and excluding energy products (CPI-ATE) has moved up over the past year. Underlying inflation has been higher than projected in the June Report, and 12-month CPI-ATE inflation was 3.7% in August. The rise is primarily attributable to higher imported goods inflation, which in turn reflects the krone depreciation through winter and spring. Norges Bank’s expectations survey indicates that inflation expectations in the somewhat longer term are well-anchored around the inflation target.

This year’s wage settlement 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%. A marked decline in the number of low-wage employees in isolation lifts annual wage growth somewhat. Overall, it appears that wage growth in 2020 may be broadly as assumed in the June Report.

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. Activity has picked up through summer but is still lower than at the start of the year. Even though unemployment has moved lower, it remains high. There is considerable uncertainty surrounding the further recovery of the Norwegian economy. The increase in infection rates and reintroduction of some containment measures may put a brake on the upswing in the coming period. Once a vaccine is widely available, growth is likely to pick up. Nevertheless, it will 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. 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. In its discussion of the balance of risks, the Committee was also concerned 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 is little changed since June and implies a rate at the current level over the next couple of years, followed by a gradual rise as activity approaches a more normal level. With such a policy rate path, there are prospects that capacity utilisation will gradually increase and that the output gap will close towards the end of the projection period. Unemployment is projected to edge lower, but to remain somewhat higher than prior to the pandemic. Underlying inflation is projected to lie above the inflation target over the next year, before gradually falling to close to 1.5%.

If output and employment increase faster than projected, or there are signs of accumulating financial imbalances, a policy rate rise may occur earlier than indicated. If the downturn lasts longer than projected, for example, owing to a resurgence in infections or because it takes a long time before a vaccine becomes available, the policy rate may remain at the current level longer than implied by the rate path.

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
Jon Nicolaisen
Ingvild Almås
Jeanette Fjære-Lindkjenn

23 September 2020