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. There is substantial uncertainty surrounding the economic recovery ahead. Since the December 2020 Monetary Policy Report, higher infection rates and stricter containment measures have weighed on activity, but there are prospects for a somewhat faster upturn through 2021 than projected earlier.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to keep the policy rate unchanged at 0% at the monetary policy meeting on 17 March. In the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised in the latter half of 2021.

Higher than expected global growth, but containment measures continue to impede the recovery

After the Covid-19 outbreak led to a marked decline in spring 2020, economic activity among Norway’s trading partners has picked up considerably. Despite higher infection rates and stricter containment measures in many countries through autumn, overall activity held up and was higher in 2020 Q4 than projected in the December Report. Since December, the number of new cases has declined, but strict containment measures continue to weigh on economic growth. On the other hand, a faster vaccine rollout will likely lift growth through 2021. In addition, stronger fiscal stimulus in the US will boost growth. Increased capacity utilisation and higher commodity prices and freight rates will likely push up inflation ahead, but there are prospects that global inflation will remain close to or below inflation targets in the coming years.

Market-implied rates indicate an increase in policy rate expectations since December, but there are still expectations of rates close to zero for some time ahead. The decline in infection rates and a higher supply of vaccines have fuelled a further rise in global equity markets. Since the December Report, long-term interest rates have also risen among all of Norway’s main trading partners.

Oil and gas prices have risen considerably since the December Report. Futures prices have risen less, indicating some decline in oil and gas prices in the coming years.

The krone exchange rate, as measured by the import-weighted index I-44, has appreciated in recent months and is now back at pre-pandemic levels. The krone appreciation likely reflects reduced uncertainty in global financial markets and a rise in oil prices. The krone is now stronger than projected in December.

Norwegian money market premiums have risen and have been higher than expected. Mortgage rates are little changed since the December Report. Market-implied rates indicate that Norwegian policy rate expectations have risen since December and now suggest that the next move will be a policy rate hike towards the end of 2021.

Prospects for a pronounced recovery over summer

Economic activity in Norway has also picked up after a sharp fall in spring 2020. The recovery continued towards the end of 2020, but mainland GDP was still 1.5% lower in January than prior to the pandemic. The level was higher than projected in the December Report.

Higher household demand has been the main driver of activity in the mainland economy since spring 2020. Household consumption of goods has picked up markedly, but overall consumption remains low. National accounts figures show that consumption in 2020 Q4 was higher than projected in the December Report and that demand for services held up well despite stricter containment measures. A long period of limited consumption opportunities has led to an increase in household savings. This provides room for strong consumption growth ahead, but it is highly uncertain how quickly and how far the saving ratio will fall.

Since the turn of the year, economic activity has likely been hampered by higher infection rates and stricter containment measures, with services related to culture, hotels, restaurants, transport, as well as some retail trade segments in southeastern Norway particularly hard hit. At the same time, closed borders create challenges for industries heavily reliant on foreign labour. In February, the enterprises in Norges Bank’s Regional Network reported a decline in activity over the past three months, but expected higher activity over the next six months.

The number of furloughed workers has risen recently. Registered unemployment has risen to 4.0%, which is higher than projected in the December Report. Long-term unemployment has declined slightly but remains high.

The Government has taken new fiscal policy measures in response to higher infection rates and tighter containment measures, which implies higher public spending in 2021 than assumed in the December Report.

Information from the public health authorities suggests that the vaccine rollout may occur faster than assumed in the December Report. As an increasing share of the population is vaccinated, infection rates will decline and containment measures will be eased. This will give a clear boost to economic activity through 2021. There is still uncertainty about the evolution of the pandemic and its economic impact.

House prices have continued to rise and have recently been higher than projected. Housing market turnover has been high, and the stock of unsold existing homes has declined markedly. Household credit growth has edged up slightly, in line with the projections in the December Report.

Higher consumer price inflation, but underlying 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, reflecting the krone depreciation through winter and spring last year. In recent months, inflation has moderated, and in February, the 12-month rise in the CPI-ATE was 2.7%, somewhat lower than projected in the December Report. Norges Bank’s Expectations Survey indicates that inflation expectations in the somewhat longer term are well-anchored around the inflation target.

Movements in energy prices have resulted in wide gaps between CPI and CPI-ATE inflation in recent years. A sharp rise in electricity prices contributed to an increase in 12-month CPI inflation from 1.4% in December to 3.3% in February, which was substantially higher than projected. Futures prices for electricity and fuel have increased since December and indicate a faster rise in energy prices in 2021 than expected earlier. CPI inflation may therefore prove to be markedly higher in 2021 than projected in the December Report.

Wage growth in 2020 proved to be clearly higher than projected in the December Report. National accounts figures show growth in average annual wages of 3.1% in 2020, which is substantially higher than the negotiated wage norm. A marked decline in the number of employees in low-wage sectors by itself pushed up overall annual wage growth. These compositional effects have likely been more pronounced than assumed earlier. There are prospects for moderate wage growth ahead, but the pandemic and wide differences across sectors make it demanding to interpret wage and cost developments and increase the uncertainty surrounding nominal developments.

Somewhat earlier rate hike

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 since spring 2020, but the recovery is being held back by higher infection rates and strict containment measures. On the other hand, new information suggests that a large portion of the adult population in Norway will be vaccinated before the end of summer. At the same time, global economic developments are better than expected. This may result in a faster pick-up in economic activity than previously projected. Nevertheless, it will probably take time for employment and unemployment to return to pre-pandemic levels. Underlying inflation is still above the target, but has moderated in recent months.

In considering 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. There are some signs of higher cost growth both globally and in Norway, but the krone appreciation and prospects for moderate wage growth suggest that inflation will move down ahead. The Committee also placed weight on the marked rise in house prices since spring 2020. A long period of low interest rates increases the risk of a build-up of financial imbalances.

In the Committee’s current assessment, the overall outlook and balance of risks imply a continued expansionary monetary policy stance. In spring 2020, the policy rate was reduced to 0%. The Committee does not envisage making further policy rate cuts. When there are clear signs that economic conditions are normalising, it will again be appropriate to raise the policy rate gradually from today’s level.

There is substantial uncertainty surrounding the economic recovery ahead, but there are prospects that economic activity will approach a normal level earlier than projected in the December Report. The policy rate forecast implies a gradual rise from the latter half of 2021. This implies a somewhat faster rate rise than projected in December. Capacity utilisation is projected to increase gradually so that the output gap turns positive at the beginning of 2022. Unemployment is projected to decline, but to 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 1.7% 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 be raised in the latter half of 2021.

Øystein Olsen
Ida Wolden Bache
Ingvild Almås
Jeanette Fjære-Lindkjenn

 

17 March 2021