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Chart: Policy rate kept unchanged at 4.5 percent

The Monetary Policy and Financial Stability Committee decided to keep the policy rate unchanged at 4.5 percent.

Norges Bank is tasked with keeping inflation low and stable. The operational target is inflation of close to 2 percent over time. We are also mandated to help keep employment as high as possible and to promote economic stability. 

Inflation is still high. In order to return inflation to target, we have raised the policy rate substantially over the past couple of years. In December, the policy rate was raised to 4.5 percent, and we signalled that it would remain at that level for some time ahead. New forecasts have not been prepared for this meeting, but we have assessed new information against the December forecasts. Our assessment is that the outlook has not changed materially since then. 

Chart: International inflation has declined

Other central banks have also raised policy rates significantly in recent years in order to bring down inflation. Inflation among trading partner countries declined through last year, partly reflecting lower energy prices but also a slower rise in prices for other goods and services. The market’s interpretation of the outlook indicates that a number of central banks will lower their policy rates in the course of spring. 

Chart: The krone has appreciated 

The krone depreciated considerably through autumn last year. Since the December monetary policy meeting, the krone has appreciated again and more than expected. The appreciation has coincided with a rise in domestic market interest rates at the same time as international rates have fallen. The krone exchange rate is not a policy target, but we are concerned with the krone exchange rate insofar as it affects the inflation outlook. A stronger krone contributes to reducing import price inflation. 

Chart: Low growth in the Norwegian economy 

Economic growth in Norway is low. Household consumption appears to have held up better towards the end of last year than we projected in December. On the other hand, the level of new homes sales is low, as is the level of construction activity. In contrast to the construction industry, the oil services industry is experiencing vigorous growth. 

The employment rate is high, and unemployment is low. At the same time, there are signs that the labour market is less tight than earlier. Employment growth has declined, and unemployment increased a little through last year. Unemployment has evolved as we projected in December, while employment appears to be slightly higher than projected.

Chart: Inflation broadly in line with projections

Price inflation has declined since last summer but remains markedly above the inflation target. Energy prices increased through autumn so that overall consumer price inflation has moved back up somewhat. Excluding energy prices and indirect tax changes, inflation moved down to 5.5 percent in December broadly as projected, with a fall in both imported goods inflation and the rate of increase in domestic goods and services prices. 

Chart: Policy rate will likely remain at the current level for some time

The Committee assesses that the policy rate is now sufficiently high to return inflation to target within a reasonable time horizon. Monetary policy is having a tightening effect, and the economy is cooling down. It will take time before we see the full effects of the past rate hikes. At the same time, business costs have risen considerably in recent years. Continued high wage growth and the krone depreciation through last year will likely restrain disinflation. We therefore believe a continued tight monetary policy stance will be needed for some time ahead. Further out, when inflation comes down and economic conditions so warrant, the Committee can start lowering the policy rate.

There is uncertainty about future developments in the Norwegian economy. If input cost inflation remains elevated or the krone depreciates again, price inflation may remain high longer than projected. In that case, the Committee is prepared to raise the policy rate again. If there is a more pronounced slowdown in the Norwegian economy or inflation declines more rapidly, the policy rate may be lowered earlier than envisaged in December.

The countercyclical capital buffer is intended to strengthen banks’ solvency and mitigate the risk that banks amplify an economic downturn. According to the capital framework, the countercyclical capital buffer is intended, in principle, to range between 0 percent and 2.5 percent. Norges Bank will normally set the buffer rate in the upper part of this range. Norges Bank sets the countercyclical capital buffer rate each quarter.

Growth in the Norwegian economy slowed through 2023 and has been low recently. Unemployment is low, but the economy is now cooling down and employment growth is weak.

Many households are highly indebted, and property prices rose considerably over many years. There is still a heightened risk that these financial system vulnerabilities may amplify an economic downturn (see Financial Stability Report 2023 - H2).

For many years, debt rose faster than household income. Over the past two years, debt growth has been slower than income growth and is now appreciably lower than its historical average. However, owing to high debt levels and higher interest rates, households need to spend a larger share of their income on interest payments. Analyses in Financial Stability Report 2023 - H2 show that the vast majority of households can service their debt, but many households will have to tighten consumption. A markedly sharper-than-expected tightening of consumption may lead to bank losses on corporate exposures and amplify an economic downturn through tighter credit standards.

House price inflation was low in 2023 and lower than household income growth. Existing home sales were approximately at a normal level, but the stock of unsold existing homes has increased markedly. New home sales have fallen over a long period and are at a low level. The outlook for house prices is more uncertain than normal. Large and abrupt falls in house prices may trigger higher losses on banks’ exposures. The risk of a pronounced decline in house prices is dampened by low construction activity and low unemployment.

Banks’ high commercial real estate (CRE) exposures are a key financial system vulnerability. For a long period, low interest rates fuelled a rapid rise in commercial property prices. In 2023, the rise in long-term interest rates pushed up estimated CRE yields, and selling prices have fallen since summer. Long-term interest rates are lower than in November but remain high relative to CRE yields.

Higher interest expenses reduce CRE firms’ profitability, and lower selling prices lower their equity ratios. Since high employment is helping sustain demand for office space, most firms will be able to cope with higher interest expenses. Lower equity ratios and profitability will make rolling over maturing loans more demanding. This may force fire sales of properties, which can amplify a fall in property prices. If rental income developments in the CRE sector prove markedly weaker than expected and selling prices fall sharply, many firms will have problems servicing debt. This may lead to substantial bank losses.

In Norges Bank’s quarterly lending survey, banks as a whole reported unchanged credit standards in 2023. The exception is CRE, where banks in a number of surveys reported that they are setting somewhat stricter equity and debt-servicing capacity requirements for new loans. In the most recent survey, banks expected unchanged credit standards for households and firms in 2024 Q1. Risk premiums in the corporate bond market have fallen since November and reduced the cost of new bond issues. Risk premiums for CRE firms have also fallen but are still higher than normal. In the Bank’s overall assessment, creditworthy households and firms have ample access to credit.

Norwegian banks satisfy capital and liquidity requirements by a solid margin. Norwegian banks are highly profitable, and interest margins have risen since the tightening cycle began in 2021, at the same time as losses have been low.

The capital requirements reflect the vulnerabilities in the Norwegian financial system. If there is a sharp economic downturn, credit losses may prove to be so large that banks will operate at a loss and have to draw on the capital they have built up. Norwegian banks are resilient and are able to absorb losses and maintain lending in a severe economic downturn. The countercyclical capital buffer rate of 2.5 percent helps banks to preserve that resilience.

The Committee unanimously decided to keep the countercyclical capital buffer rate at 2.5 percent.

Ida Wolden Bache
Pål Longva
Øystein Børsum
Ingvild Almås
Steinar Holden

24 January 2024