Activity in the Norwegian economy is high, with little spare capacity. Inflation is markedly above the 2% target. Since the March 2022 Monetary Policy Report, unemployment has fallen more than expected, and inflation has risen faster than projected. With rising wage growth and imported goods inflation, there are prospects that inflation will remain above the target for some time. Prospects for a more prolonged period of high inflation suggest a tighter monetary policy than projected earlier.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.75% to 1.25% at its meeting on 22 June. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further to 1.5% in August.

High inflation and weaker global growth outlook

Economic activity among Norway’s trading partners continued to rise broadly as expected in 2022 Q1. Labour market conditions have continued to improve, and unemployment has returned to pre-pandemic levels in many countries. Wage growth is on the rise and has been higher than projected in the March Report.

High energy prices and the combination of strong demand and supply constraints have led to a pronounced rise in global consumer price inflation. Since March, underlying inflation among trading partners has risen more than projected. High inflation is broad-based, and both goods and services inflation is high in many countries. Energy and food prices remain elevated, partly owing to the war in Ukraine. Oil prices have risen further, while spot gas prices are little changed. Oil and gas futures prices are higher than in March. Freight rates from China to Europe have fallen.

Uncertainty about the outlook for global growth and inflation has resulted in considerable financial market volatility. Global policy rate expectations have risen substantially since the March Report. A number of central banks have raised policy rates in order to tame inflation, and many have signalled a faster rate rise ahead. Long-term interest rates have also risen since March. Corporate bond risk premiums have increased, and global equity indexes have fallen.

High inflation and higher interest rates are reducing household purchasing power and are likely to curb consumption growth in many countries ahead. Along with intermediate goods shortages and production constraints, this is expected to dampen global economic growth. The projections for trading partner growth are now lower than in the March Report, while the projections for underlying inflation have been revised up.

The krone has depreciated and is weaker than projected. Norwegian money market premiums have declined. Norwegian market rates have moved up, reflecting expectations of further policy rate rises through the year. The rise in residential mortgage rates has been approximately as expected.

High activity and little spare capacity in the Norwegian economy

Economic activity has picked up quickly following the decline caused by the Omicron wave in winter. Mainland GDP was a little lower in April than projected in the previous Report. At the same time, there was strong growth in the sectors that had been most affected by pandemic-related restrictions. Household consumption has risen further and has been a little higher than projected. Services consumption moved up quickly through spring and is now back at pre-2020 levels, while demand for goods has been higher than expected.

Employment has continued to rise, and the labour market is tight. In May, Norges Bank’s Regional Network contacts reported growing shortages of labour and intermediate goods. Contacts expected activity growth to slow somewhat over the next six months, with many citing capacity constraints as the reason for the slowdown. The share of contacts reporting capacity problems and output constraints due to labour shortages is now just as high as around the cyclical peak preceding the financial crisis. Strong demand for labour is confirmed by the high number of job vacancies. Seasonally adjusted unemployment fell to 1.7% in May, which is lower than projected in the March Report.

After a period of a rapid post-pandemic recovery, activity in the Norwegian economy has risen to a high level. There are prospects of somewhat slower growth ahead. Higher inflation and rising interest rates will likely curb growth in household consumption in the coming years. At the same time, solid growth in petroleum investment and business investment is expected to help lift activity.

The Revised National Budget for 2022 indicates a fiscal stance broadly in line with that assumed and implies a somewhat tighter fiscal policy in 2022 than in 2021. Petroleum revenue spending remains elevated in 2022, partly reflecting extraordinary pandemic-related spending, government support for electricity bills and measures related to the war in Ukraine.

Turnover in the market for existing homes has been high, and house price inflation has been higher than projected in recent months. Household credit growth has been a little lower than projected.

Inflation above the target

Inflation in Norway has climbed further. The 12-month rise in the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE) was 3.4% in May, which was higher than projected. The increase in CPI-ATE inflation appears to be broad-based. Prices for both imported goods and domestically produced goods and services have risen more than projected. Wage growth is on the rise, and producer prices for imported goods have increased more than expected. In conjunction with the krone depreciation, this will push up inflation ahead.

Other indicators of underlying inflation have also risen and are, overall, higher than the CPI-ATE. Longer-term inflation expectations have risen slightly and are now somewhat above 2%.

The overall consumer price index (CPI) has been pushed up by high energy prices. Government support to compensate for the surge in electricity prices has curbed the increase in energy prices faced by households, but 12-month CPI inflation was nevertheless 5.7% in May. This is considerably higher than projected in the March Report, owing in part to a faster-than-expected rise in energy prices.

This year’s wage settlements so far appear to be consistent with the wage growth projection in the March Report. Nevertheless, a tight labour market may result in somewhat faster wage growth than projected earlier. Annual wage growth in 2022 is now projected at 3.9%, which is higher than in March. The projection for wage growth is in line with the wage expectations of the social partners and Regional Network contacts.

Need for higher interest rates in Norway

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.

Activity in the Norwegian economy is high, with little spare capacity. Unemployment has fallen more than expected and is at a very low level. Inflation is markedly above the target. Underlying inflation has picked up quickly and has been higher than projected. With rising wage growth and imported goods inflation, there are prospects that inflation will remain above the target for some time.

The policy rate is still low, and monetary policy is expansionary. In the Committee’s assessment, a markedly higher policy rate is needed to stabilise inflation around the target. Given a tight labour market, employment will likely remain high even with a higher policy rate ahead.

Prospects for a more prolonged period of high inflation suggest a faster rise in the policy rate than projected earlier. A faster rate rise now will reduce the risk of inflation remaining high and the need for a sharper tightening of monetary policy further out.

The policy rate forecast has been revised up from the March Report and indicates a rise in the policy rate to around 3% in the period to summer 2023. This is above what is estimated to be a neutral policy rate. With such a path for the policy rate, there are prospects that inflation will drift down and approach target further out. Capacity utilisation is projected to remain above a normal level in the coming years, and unemployment is projected to remain low. House price inflation and credit growth are expected to moderate.

In its discussion of the balance of risks, the Committee was concerned with the risk of inflation moving higher than anticipated against the background of little spare capacity in the Norwegian economy, sustained global inflationary pressures and a weaker krone. In that case, the policy rate may be raised more than currently projected. On the other hand, there is also a risk that rapid rate increases abroad will lead to an abrupt slowdown in growth, with global inflationary pressures easing faster than assumed. The rise in interest rates in Norway may also cool down the housing market and curb household consumption to a greater extent than expected. If inflation and capacity utilisation fall faster than projected, the policy rate may be raised less than currently projected.

The Committee decided unanimously to raise the policy rate to 1.25%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further to 1.5% in August.

 

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

 

22 June 2022