Lower international inflation and expectations of policy rate cuts

Consumer price inflation among Norway’s main trading partners has declined markedly over the past couple of years and is approaching the inflation targets of a number of central banks. Core inflation has also fallen markedly but is somewhat higher than headline inflation. Economic activity among trading partners increased in Q2 broadly in line with projections. In many countries, labour market tightness has eased recently. Oil prices have fallen since June.

Many central banks have expressed increased confidence that inflation will be close to their inflation targets ahead, and that the current tight monetary policy stance is no longer warranted. Central banks in a number of main trading partner countries have reduced their policy rates, and market expectations indicate further cuts both this year and next. Policy rate expectations have fallen considerably since the June 2024 Monetary Policy Report, and by somewhat more abroad than in Norway. Market pricing indicates a reduction in the Norwegian policy rate towards the end of this year. Long-term interest rates are also lower than at the time of the June Report. The krone has depreciated and is weaker than projected in June.

Weak growth in the Norwegian economy

Growth in the Norwegian economy was low through last year and has remained sluggish so far this year. In 2024 Q2, growth was slightly lower than expected. Household consumption increased in Q2, but in July slumping car sales contributed to a fall in goods consumption. Housing investment continued to fall in Q2 from an already low level. New home sales have picked up a little so far this year, but it will likely take time before housing investment starts to rise again. In the secondary market, house prices have increased since the June Report, but are slightly lower than projected.

Norges Bank’s Regional Network enterprises expect some increase in overall activity in the second half of 2024 and slightly higher growth than in the first half-year. There are still wide differences across industries. Services contacts report solid demand and expect activity to increase further in the near term. Oil services expect continued strong growth. Manufacturing contacts expect weak growth in activity, while construction industry and retail trade contacts expect a decline.

Overall output in the Norwegian economy appears to have been around potential since the beginning of the year. Registered unemployment has shown little change in recent months and was 2.0% in August, as projected in the June Report. LFS unemployment data indicate that unemployment has been stable around 4% since March 2024. Employment was little changed in Q2, broadly as expected.

Growth in the Norwegian economy is set to be slightly lower in the near term than projected in the June Report. Growth is projected to pick up a little in the second half of 2024 but to remain low. In the short term, a decline in housing and business investment will likely weigh down on activity, while an increase in consumption will lift activity. Petroleum investment will likely boost activity both this year and next, with investment now expected to be higher than previously assumed. Public demand will also support activity ahead. In the projection, capacity utilisation is expected to drift further down over the next year with output running at somewhat below potential.

Declining inflation

Inflation has fallen further since the June Report and has been lower than expected. In recent months, inflation has been pushed down by a fall in energy prices. In August, the 12-month rise in consumer price index (CPI) moved down to 2.6%, while CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) slowed to 3.2%. The average of other underlying inflation indicators has also decreased. Reduced child daycare prices dampened inflation in August and will continue to restrain the 12-month rise in consumer prices over the next year. In the near term, low energy prices will dampen inflation.

High wage growth and weak productivity growth will contribute to keeping growth in business costs at a high level ahead. Wage growth is projected at 5.2% in 2024, as in the June Report. Wage growth is expected to moderate next year, as indicated by Norges Bank’s Regional Network and Expectations Survey. The social partners have lowered their wage expectations for 2025 since June.

According to the Expectations Survey, long-term inflation expectations fell slightly in Q3 but are still somewhat higher than the 2% inflation target.

Policy rate unchanged at 4.5%

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.

In recent years, the policy rate has been raised significantly to tackle high inflation. Since December 2023, the policy rate has been held at 4.5%. The interest rate has contributed to cooling down the Norwegian economy and to dampening inflation. Unemployment has edged up from a low level. Inflation has declined markedly from its peak, but underlying inflation has not declined to the same extent. Moreover, the rapid rise in business costs and the krone depreciation are expected to restrain further disinflation. 

Since the June Report, inflation has been lower than expected. International policy rates appear to be coming down faster. On the other hand, the krone has depreciated. Developments in the Norwegian labour market have been broadly in line with the projections in the June Report.

The Committee judges that a restrictive monetary policy is still needed to bring inflation down to target within a reasonable time horizon. The Committee is concerned with the possibility that if the policy rate is lowered prematurely, inflation could remain above target for too long. On the other hand, an overly tight monetary policy could contract the economy more than needed. In assessing the trade-offs between these considerations, the Committee concluded that it is appropriate to keep the policy rate at today’s level for a period ahead but that the time to ease monetary policy is approaching.  

The policy rate forecast in this Report implies that the policy rate will remain at 4.5% to the end of 2024 before being gradually reduced from 2025 Q1. The forecast is little changed from the June Report but indicates a slightly faster decline in the policy rate through 2025. Economic growth is set to pick up slightly in the years ahead. Unemployment will likely edge up. Inflation is projected to approach 2% towards the end of 2027.

There is uncertainty about future developments in the Norwegian economy. In its discussion, the Committee noted in particular that inflation has fallen markedly and been lower than projected for a time. Underlying inflationary pressures may be weaker than currently assumed. If prospects suggest that inflation will return to target faster or there is a more pronounced slowdown in the Norwegian economy, the policy rate may be lowered faster than currently envisaged. On the other hand, the krone has depreciated again. If the krone depreciates further or capacity utilisation increases, wage and price inflation could remain elevated for longer. A higher policy rate than currently envisaged may then be required.

The Committee unanimously decided to keep the policy rate unchanged at 4.5%. Based on the Committee’s current assessment of the outlook, the policy rate will most likely be kept at that level to the end of 2024.

Ida Wolden Bache
Pål Longva
Øystein Børsum
Ingvild Almås
Steinar Holden

18 September 2024