Activity in the Norwegian economy has continued to rise after Covid-19 containment measures were removed in winter. Since the December 2021 Monetary Policy Report, unemployment has fallen to a low level, and price and wage inflation has been higher than expected. The war in Ukraine has created heightened uncertainty about the economic outlook, but there are prospects of a continued upturn in the Norwegian economy. Rising wage growth and imported goods inflation are expected to push up inflation ahead. The objective of stabilising inflation around the target somewhat further out suggests a higher policy rate.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to raise the policy rate from 0.5% to 0.75% at its meeting on 23 March. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June.

The war in Ukraine creates heightened uncertainty about the outlook for global growth and inflation

Economic activity among Norway’s trading partners has continued to rise. In 2021 Q4, trading-partner GDP growth was a little higher than projected in the December Report. Labour markets have improved, and wage growth is on the rise. The Omicron wave this winter proved to be more short-lived in advanced countries than assumed in the December Report, and most containment measures have been lifted in many countries.

High energy prices, a surge in freight rates and long delivery times have driven up headline consumer price inflation in many countries. Underlying inflation among trading partners has also moved up, and inflation expectations have increased.

Russia’s invasion of Ukraine has led to heightened uncertainty about global economic developments ahead. Prices for many commodities, including oil and gas, have risen since December, and supply chain disruptions may last longer. High inflation, export market disruptions and greater uncertainty among households and firms are expected to weigh on economic growth ahead, especially in Europe. The economic upturn among trading partners is expected to continue, but growth prospects appear to be weaker than projected in the December Report. The projections for global price and wage inflation are higher than in December.

Uncertainty associated with the war in Ukraine has resulted in financial market volatility. Global equity indexes have fallen, and corporate bond risk premiums have risen. Norwegian money market premiums have also moved up. The krone has appreciated more than projected in the December Report, likely reflecting the rise in oil prices.

Global policy rate expectations have increased on the back of higher inflation and higher inflation expectations. Long-term sovereign bond yields have largely tracked policy rate expectations. Norwegian market rates have also increased and indicate expectations of a further rise in the policy rate. Residential mortgage rates have moved up broadly as expected in response to the policy rate hikes in 2021.

High employment and little spare capacity in the Norwegian economy

Higher infection rates and containment measures led to a dip in activity around the turn of the year, and mainland GDP was lower than projected in the December Report. However, the impact of the most recent infection wave was less pronounced than assumed in December. In mid-February, the Government removed all domestic containment measures, and uncertainty about the further evolution of the pandemic receded.

Information from Norges Bank’s Regional Network and card transaction data both point to a rapid recovery of activity in sectors most affected by containment measures. Recently, employment has also risen substantially. Moreover, a large share of Regional Network contacts reported capacity and production constraints due to labour shortages in February. The strong demand for labour is evidenced in the large number of job vacancies. Seasonally adjusted registered unemployment fell to 2.1% in February, which is lower than projected in the December Report. Capacity constraints are likely to pull down on growth in the Norwegian economy ahead.

The war in Ukraine has led to heightened uncertainty about the economic outlook for Norway. High energy prices are generating substantial government revenue and may drive up petroleum investment and energy exports but will also increase expenses facing households and firms. Some firms may also face supply problems and faltering foreign demand. While lower growth in real household disposable income is likely to curb growth in private consumption, there are still prospects for a continued upswing in the Norwegian economy.

Petroleum revenue spending in 2022 is likely to be higher than assumed in the December Report. The increase in spending relates among other things to measures to strengthen military readiness, refugee intake from Ukraine and prolonged government support for households’ electricity bills. The government’s overall budget plans still imply a tighter fiscal policy than in 2021.

House prices rose markedly at the beginning of 2022 and have been higher than projected. The rise is likely related to the new regulation on the sale of real property, effective from the beginning of this year, in addition to strong housing demand and the low supply of homes for sale. The impact of the new regulation is likely to be transitory, and house price inflation is expected to move down ahead.

Expectations of higher price and wage inflation

High energy prices have driven up the level of overall CPI. Following a rise towards the end of 2022, 12-month CPI inflation has slowed again and was 3.7% in February. Government support to compensate for the surge in electricity prices has pulled down energy price inflation more than expected, but CPI inflation has still been higher than projected in the December Report.

The rise in the consumer price index adjusted for tax changes and excluding energy products (CPI-ATE) has picked up from the low levels in autumn. The rise in prices for both imported goods and domestically produced goods and services has increased. In February, 12-month CPI-ATE inflation was 2.1%, which was higher than projected in December. Other indicators of underlying inflation have also risen and are overall higher than the rate of increase in the CPI-ATE. Inflation expectations have risen, especially at the one- to two-year horizon. Longer-term inflation expectations are somewhat above 2%.

Wage growth in 2021 turned out to be higher than projected in the December Report. At the same time, wage expectations for 2022 have risen, probably reflecting increased labour demand and high consumer price inflation. Annual wage growth in 2022 is now projected at 3.7%, which is higher than in the December Report.

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 has continued to rise after containment measures were lifted in winter. Employment has increased further, and capacity utilisation appears to be above a normal level. The war in Ukraine has led to heightened uncertainty about the economic outlook, but there are still prospects for a continued upswing in the Norwegian economy. Price and wage inflation has been higher than projected, and wage expectations have risen. Rising wage growth and imported goods 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 a higher policy rate. Higher interest rates will ease the pressures in the Norwegian economy, but employment will likely remain elevated. Uncertainties relating to the economic outlook and households’ response to higher interest rates warrant a gradual rise in the policy rate.

The policy rate forecast has been revised up from the December Report and indicates a rise in the policy rate to around 2.5% at the end of 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 move close to target somewhat further out. Capacity utilisation remains above a normal level in the projection period, and unemployment remains 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 prospect that the war in Ukraine could result in weaker-than-expected global growth amid rising inflation. The Committee was also concerned with the risk of accelerating price and wage inflation as a result of capacity constraints in the economy 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 0.75%. Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June.

 

Ida Wolden Bache
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

23 March 2022