The reopening of society has led to a marked upswing in the Norwegian economy, and activity is now higher than its pre-pandemic level. Since the June 2021 Monetary Policy Report, unemployment has fallen further. Infection rates have risen, but a large proportion of the adult population is now vaccinated. A normalising economy now suggests that it is appropriate to begin a gradual normalisation of the policy rate.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0% to 0.25% at its meeting on 22 September. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in December.

The global recovery continues

The easing of Covid-related restrictions has led to a clear upswing in economic activity among Norway’s trading partners, as projected in the June Report. Through summer, the spread of the Delta variant resulted in higher infection rates in many countries. The share of fully vaccinated has risen among most trading partners, and so far there has not been any significant tightening of Covid-related restrictions among advanced economies. The rise in cases is expected to weigh somewhat on the economic recovery in the coming period, but expansionary monetary and fiscal policies will likely help sustain a relatively solid rate of growth. Overall economic activity among trading partners is projected to be back at its pre-pandemic level during the current quarter.

The pandemic has fuelled substantial price increases for some goods and services, and headline consumer price inflation has risen in many countries. Underlying inflation in the US and UK has been somewhat higher than projected. Nevertheless, there are prospects for moderate underlying inflation among trading partners in the coming years.

Foreign central banks are signalling a continuation of loose monetary policy for some time ahead. Policy rate expectations among Norway’s trading partners have increased slightly since June and indicate that rates will be broadly at current levels in the period to the end of 2022, rising gradually thereafter.

US long-term interest rates have fallen a little since the June Report, likely on the back of unease about infection rates and uncertainty regarding the economic outlook. This uncertainty may also have affected the krone exchange rate, which has been weaker than projected in June. Oil prices are little changed since June, while gas prices have risen substantially. Advanced economy equity markets have posted further gains.

The premium in the Norwegian money market has edged higher but has been somewhat lower than projected in the June Report. Residential mortgage rates are little changed. Forward money market rates have risen a little, indicating expectations of a gradual policy rate rise ahead.

Activity in the Norwegian economy is now higher than its pre-pandemic level

After falling sharply in 2020, overall activity in Norway has picked up again. The easing of Covid-related restrictions has led to a brisk upswing in the Norwegian economy. In July, mainland GDP was a little higher than prior to the pandemic and broadly as projected in the June Report. The recovery was particularly strong in private services, which have been hit hardest by Covid-related restrictions.

Infection rates in Norway have risen after summer, especially among the young. Hospitalisations have also risen, but considerably less than earlier in the pandemic. A large proportion of the adult population is now vaccinated, and vaccination of younger age groups is underway. A high vaccination rate has reduced the need for Covid-related restrictions, and the economic impact of higher infection rates is therefore expected to be less pronounced than previously. At the same time, there is still uncertainty regarding the evolution of the pandemic and the effectiveness of existing vaccines. New virus variants may cause new infection waves even in countries with a high vaccination rate, and it cannot be ruled out that a retightening of restrictions may be necessary. 

Higher infection rates are likely weighing somewhat on the economic upturn, but there are still prospects that activity will continue to rise through autumn. The upswing is expected to be strongest in the service sector segments that have been hit hardest by the pandemic. In August, Norges Bank’s Regional Network contacts reported higher capacity utilisation and growing labour shortages in most sectors. Nevertheless, contacts expect solid growth over the next six months, especially in services.

Owing to limited spending options, households have accumulated substantial savings during the pandemic, providing room for strong private consumption growth ahead. Household purchases of goods and services rebounded through summer and have been higher than expected. In August, Regional Network contacts reported improved profitability and plans for higher investment in the coming year.

The reopening of society has enabled more persons to return to work. Seasonally adjusted registered unemployment has fallen more than expected and was 2.7% in August. At the same time, a large share of unemployed have been out of work for over half a year. Long-term unemployment increases the risk of a permanent drop-out from the labour market.

Through the pandemic, extensive fiscal measures have been implemented to dampen the economic impact of the pandemic and the stringent measures to contain it. With the reopening of society and a normalising economy, the Government has signalled that most support measures will be phased out in the course of autumn.

Housing market activity remains high, but house price inflation has moderated. Through summer, the rise in house prices has been somewhat lower than projected. Household credit growth has been broadly in line with expectations.

Increased wage expectations

Underlying inflation, as measured by the consumer price index (CPI) adjusted for tax changes and excluding energy products (CPI-ATE), picked up through spring and summer 2020 but has since declined. In August, the 12-month change was 1.0%, as projected in the June Report. The rise in prices for both domestically produced goods and services and imported consumer goods has slowed since May. 

A rise in energy prices led to a substantial increase in 12-month CPI inflation towards the end of 2020 and into 2021. After inflation moderated through spring, a resurgence in energy prices has led to a renewed rise in 12-month CPI inflation, which was 3.4% in August. Electricity and fuel futures prices indicate that CPI inflation will remain elevated to the end of 2021, declining thereafter. Longer-term inflation expectations appear to remain anchored close to the 2% target.

Average annual wages rose by 3.1% in 2020. A considerable decline in the number of employed in low-wage sectors contributed to lifting the average wage level. As a rising number of unemployed return to work, this compositional effect will likely pull down wage growth. Current wage statistics and signals from expectations surveys suggest that wage growth in 2021 will be higher than projected in the June Report, and annual wage growth for 2021 is now projected at 3.0%.

The pandemic is creating uncertainty regarding price and wage inflation ahead. For example, bottlenecks may arise in distribution chains, and some occupational labour shortages may be greater than assumed. This may lead to increased pressure on prices and wages.

Gradual rise in the policy rate

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 reopening of society has led to a marked upswing in the Norwegian economy, and activity is now higher than its pre-pandemic level. Unemployment has fallen further, and capacity utilisation appears to be close to a normal level. Infection rates have risen after summer, but a high vaccination rate has reduced the need for Covid-related restrictions. The economic upswing will likely continue through autumn. Underlying inflation is low, but increased activity and rising wage growth will help push inflation up towards the inflation target. A normalising economy suggests that there is no longer a need to maintain the current degree of monetary accommodation. The objective of countering the build-up of financial imbalances also suggests higher interest rates. Uncertainty surrounding the effects of higher interest rates warrants a gradual rise in the policy rate.

In its discussion of the balance of risks, the Committee was concerned with the uncertainty surrounding the evolution of the pandemic and the restraining effect that new virus variants could potentially have on the economic upturn. At the same time, there is still a risk that the pandemic will have lasting consequences for employment. This favours supporting economic growth to enable the unemployed to return to work more quickly. On the other hand, capacity constraints may result in faster-than-expected price and wage inflation. Nevertheless, the Committee judges that the risk of inflation becoming too high is limited.

Based on the Committee’s current assessment of the outlook and balance of risks, it will be appropriate to raise the policy rate gradually in the coming period. The policy rate forecast indicates a rate of 1% one year ahead and 1.7% towards the end of 2024. Higher capacity utilisation and higher inflation prospects have contributed to a somewhat higher policy rate forecast compared with the June forecast. Capacity utilisation is now close to a normal level and is expected to rise further in the coming year before gradually falling. Unemployment is expected to fall further and then remain close to its pre-pandemic level. Underlying inflation is projected to hover around 1% in the coming period, before rising to close to 2% towards the end of 2024. If the economic outlook changes, the policy rate forecast will also be adjusted.

The Committee decided unanimously to raise the policy rate to 0.25%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in December.

 

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

22 September 2021