Measured by relative labor costs, Norwegian labor has never been as costly as it is now. One reason is the strong currency. The Norwegian krone has been characterized as “The New Swiss Franc” by international media. Sounds good, but it have become a major problem for the country’s export industry, and is about to block the Central Bank of Norway‘s plans to rise the key interest rate further.
“The Norwegian export industry may lose market shares ahead. There are no prospects of another rise in export prices as sharp as in the 2000’s.”
According to governor of the Norwegian Central Bank, Svein Gjedrem, the plans for rising the key interest rate is changed, and the central bank have changed focus from economic growth to inflation. Various measures of the underlying inflation has been close to 2,5% in recent months, and that worries Mr.Gjedrem.
Because it might force the Central Bank of Norway to raise the key interest rate further, and thereby pull the rug under the fragile economic recovery.
“Lower wage growth, reduced capacity utilization and low global inflation have counterbalanced the effects of higher energy prices and the depreciation of the krone in autumn 2008,” central bank governor Svein Gjedrem explained to fellow bankers in a speech just before the Easter holidays.
As the figure shows; the Norwegian inflation wasn’t supposed to reach 2,5% before summer 2012, but according to Mr. Gjedrem it’s almost there already now.
The Central Bank of Norway’s main goal is to keep the inflation as close to 2,5% as possible.
Over the last 10 years the central bank has managed to do so pretty well, using the key interest rate as its main tool.
But Mr.Gjedrem warns of the danger related to using interest rates to stimulate economic growth. The consequence can easily be inflation that’s out of control.
At the moment The Central Bank of Norway is kept from raising the key interest rate according to the plan presented in October 2009.
“The effect on private consumption of the substantial interest rate cuts in 2008 and 2009 has probably not been exhausted and high consumption growth is expected to continue in 2010. House prices have risen. The new guidelines for prudent residential mortgage lending issued by Finanstilsynet (the Financial Supervisory Authority of Norway) may curb household debt accumulation. Over time, household borrowing may nevertheless increase considerably and saving may fall. The aim of guarding against the risk of future imbalances, which may disturb activity and inflation somewhat further ahead, suggests that the interest rate should be gradually brought closer to a more normal level.”
“On the other hand, a marked interest rate increase in Norway and a wider interest rate differential between Norway and other countries may entail a risk of a considerably stronger-than-projected krone, resulting in inflation that is too low.”
“This will make it difficult to bring inflation up to target within a reasonable time horizon. A strong krone may also lead to lower activity in exposed industries and thereby lower capacity utilization in the Norwegian economy. This suggests that the interest rate should not be raised too rapidly.”
“Overall, the outlook and the balance of risks suggest that the key rate should be gradually increased ahead, although somewhat later than we envisaged in October 2009,” the Norwegian central bank chief says.
Here is The Central Bank of Norway’s new estimates for the key interest rates in the U.S and the Euro Zone:
As for Norway, the central bank’s estimates have a large room for variables. But this time the spread seem even larger than usual.
Towards 2014 Norway may have a key interest rate of 1,5% – or 8%.
This should be an interesting bet….
It’s the combination of a low interest rate and strong currency that worries Mr.Gjedrem the most.
The side effects are beginning to show.
For example; the wage growth is much larger that the price growth.
“Measured by relative labor costs, Norwegian labor has never been as costly as it is now. As a result, the Norwegian export industry may lose market shares ahead. There are no prospects of another rise in export prices as sharp as in the 2000’s, when Norway’s terms of trade improved considerably.”
What seem to puzzle the experts most, is the big drop in Norwegian household’s spending in spite of record high income growth due to low interest rates.
“Growth in private consumption increased through 2009 and growth is expected to continue. In spite of a lower interest rate level, the household saving ratio increased to a record-high level in 2009. This probably reflected high household debt levels with a need for some households to consolidate, and a large degree of uncertainty owing to prospects of higher unemployment and a fall in the value of housing wealth. At the same time, household real disposable income increased. Almost half the increase is attributable to a lower interest rate level.”
“Debt burdens are still high, but the stabilization of employment at a relatively low level has contributed to reducing uncertainty. The interest rate level remains low. In addition, house prices have increased. The saving ratio is therefore expected to fall, and growth in private consumption is projected at 5 per cent in 2010.”
“On 24 March, the Executive Board decided that the key policy rate should be in the interval 1½-2½ per cent in the period to the publication of the next Report on 23 June 2010 unless the Norwegian economy is exposed to new major shocks. The interest rate was kept unchanged at this meeting. This is based on the assessment that inflation and capacity utilization may for a period be slightly lower than previously projected and that the interest rate should be increased somewhat later than expected in autumn 2009.”
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