The upswing in the Norwegian economy has continued. Since the September 2021 Monetary Policy Report, activity has risen further, and unemployment has fallen. Increased infection rates and extensive containment measures are expected to dampen activity in the near term. When infection rates subside further out and containment measures are eased, the economic upswing will likely continue. Rising wage growth and higher imported goods inflation are expected to push up underlying inflation ahead. The objective of stabilising underlying inflation around the target somewhat further out suggests that the policy rate should be raised towards a more normal level.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.25% to 0.5% at its meeting on 15 December. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in March.

Increased spread of coronavirus dampens the global upswing

Economic activity among Norway’s trading partners has continued to rise. In 2021 Q3, GDP growth for trading partners overall was a little higher than projected in the September Report, and economic activity is now higher than pre-pandemic levels. Through autumn, the number of Covid cases has increased rapidly in Europe, and Covid restrictions have been tightened. At the same time, the Omicron variant is creating considerable uncertainty about the evolution of the pandemic. Against this background, economic growth among trading partners is expected to slow in the near term.

The rapid rise in demand and delays in the production and distribution of goods have resulted in long delivery times, a surge in freight rates and substantial price rises for some goods and services. Together with high energy prices, this has weighed on economic growth among trading partners and has fuelled a sharp rise in headline consumer price inflation in many countries. Inflation expectations have increased, and there are prospects that underlying inflation among trading partners will turn out higher than projected in the September Report.

Prospects for higher inflation have contributed to lifting policy rate expectations among Norway’s main trading partners. Forward rates now indicate expectations that policy rates for a number of trading partners will be raised during 2022. Long-term government bond yields are little changed.

Gas prices have continued to rise, while oil prices are little changed since the September Report. Recently, higher infection rates and uncertainty about the new virus variant have led to financial market volatility. The krone has weakened and is now weaker than projected in September.

After the policy rate was raised to 0.25% in September, most banks have raised residential mortgage rates. Forward money market rates have edged lower since September but still indicate expectations of a further rise in the policy rate.

Increased infection rates and containment measures dampen activity in the Norwegian economy

The easing of Covid restrictions through the year has led to a marked upswing in the Norwegian economy, and activity is higher than prior to the pandemic. Mainland GDP has risen further through autumn and has been broadly as projected in the September Report. The upswing has been strongest in the service sector, which was severely affected by previous Covid restrictions.

In recent weeks, infection rates in Norway have reached a new peak since the onset of the pandemic. Covid-related hospitalisations have also risen and are now higher than in spring 2020. Extensive containment measures have been reintroduced to help limit virus transmission. The Government has also announced that a large portion of the population will receive a third vaccine dose in the coming months, which could reduce the need for protracted containment measures. The projections in this Report assume that infection rates will subside further out and that the containment measures will be gradually unwound through winter. However, it cannot be ruled out that the measures will apply for a longer period or that tighter measures will be required.

In November, Regional Network contacts reported a sharp rise in capacity utilisation and production constraints due to labour shortages and global supply chain disruptions. Together with higher infection rates and containment measures, this is will dampen economic activity in the near term, while there are prospects for a continued upturn thereafter. Household purchases of goods and services have rebounded over the past six months and have been higher than expected. Owing to limited spending options, households have accumulated substantial savings during the pandemic. This should provide room for continued solid growth in private consumption when infection rates subside further out and containment measures are eased. Service sectors are expected to account for much of the economic upswing in spring 2022.

The labour market has continued to improve in pace with the increase in economic activity. Employment has risen more than projected in the September Report, and the number of job vacancies is at a high level. Seasonally adjusted registered unemployment has fallen a little more than expected and was 2.3% in November. The number of long-term unemployed has fallen. In the past week, the tightening of containment measures has led to new furlough notices, and unemployment will likely edge up in the near term.

The central government budget bill calls for somewhat lower petroleum revenue spending in 2022 than projected in the September Report. Since the budget was presented, the Government has announced support for households’ electricity bills. Fiscal policy support measures have also been reintroduced in connection with the tightening of containment measures, which will curb the economic impact of increased infection rates and pandemic-related restrictions.

Housing market activity remains high, but house price inflation has moderated. Through autumn, house price inflation and household credit growth have been broadly as expected. Housing investment has been lower than expected, which likely reflects a marked rise in construction costs.

Expectations of higher wage and price inflation

Higher energy prices have led to a sharp rise in the overall consumer price index (CPI). Twelve-month CPI inflation was 5.1% in November, higher than projected in the September Report. Futures prices for electricity and fuel indicate that the 12-month rise in energy prices will moderate after the turn of the year and that CPI inflation may be somewhat lower into 2022.

Underlying inflation, as measured by the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE), has declined since summer 2020. The rise in prices for both imported goods and domestically produced goods and services has slowed. In November, the 12-month rise in the CPI-ATE was 1.3%, a little higher than projected in the September Report. Other indicators of underlying inflation are slightly higher than the rate of increase in the CPI-ATE. Inflation expectations have also risen in Norway, especially at the one- to two-year horizon. In the period ahead, higher global prices and the surge in freight rates will likely push up imported inflation.

Current wage statistics indicate that wage growth has been broadly as expected, but high labour demand has likely pushed up wage growth a little towards the end of the year. Wage growth is therefore expected to be somewhat higher in 2021 than projected in the September Report. Wage expectations for 2022 have risen since September.

Gradual rate rise

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 upswing in the Norwegian economy has continued. Unemployment has fallen further, and capacity utilisation is estimated to be above a normal level. Increased infection rates and extensive containment measures are expected to dampen activity in the near term. When infection rates subside further out and containment measures are eased, the economic upswing will likely continue. Higher electricity prices have resulted in elevated CPI inflation, but underlying inflation is lower than the inflation target. Rising wage growth and higher imported 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 that the policy rate should be raised towards a more normal level. A gradual normalisation of the policy rate is consistent with continued high employment. Higher interest rates will also help to counter a build-up of financial imbalances.

The policy rate forecast is little changed and indicates a rise in the policy rate to around 1.75% in the course of the coming years. With such a path for the policy rate, there are prospects that underlying inflation will move close to the target in 2022. Capacity utilisation is projected to decline in the near term, but to be above a normal level in the coming years.

In its discussion of the balance of risks, the Committee was concerned with the potential economic effects of the pandemic and containment measures in the period ahead. If there is a need for more stringent and protracted containment measures that pull down economic activity through spring next year, further rate hikes may be postponed. The Committee was also concerned with a potentially higher-than-projected rise in domestic wages and prices due to capacity constraints 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 0.5%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in March.

 

Øystein Olsen
Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

15 December 2021