Jan F Qvigstad: Outlook for the Norwegian economy
Address by Mr Jan F Qvigstad, Deputy Governor of Norges Bank (Central Bank of Norway),
at Sparebank 1 Fredrikstad, 4 November 2009.
The text below may differ slightly from the actual presentation. The speech is based on the assessments
presented at Norges Bank's press conference following the Executive Board's monetary policy meeting on 28
October and Monetary Policy Report 3/09.
* * *
The operational target of monetary policy in Norway is low and stable inflation, with annual
consumer price inflation of close to 2.5 per cent over time. In recent years, average inflation
has been close to, but somewhat below 2.5 per cent. Consumer price inflation has generally
been somewhat below target since 2003 and monetary policy was then oriented towards
pushing up inflation. In 2007 and 2008 inflation picked up to slightly above target. Inflation
expectations were firmly anchored and the key policy rate was gradually raised to a more
normal level. Inflation close to target and firmly anchored inflation expectations were
essential for monetary policy to be effective when substantial cuts were made in the key
policy rate in autumn 2008 and the beginning of 2009.
It has been a year since financial turbulence developed into a full-blown crisis and resulted in
the most severe downturn in the global economy since the Second World War. The financial
crisis eroded confidence in banks, counterparties and contractual partners.
The measures implemented by central banks and governments have had a stabilising effect
on financial markets. Credit and money market premiums have decreased and activity has
picked up. Daily fluctuations have become less pronounced.
With the improvement in financial markets over the past six months and the increase in the
credit supply, global trade is now picking up slightly, albeit only gradually and from a low
level. Manufacturing output has recently risen in the US, Japan and many emerging
economies, while it continues to fall - albeit at a slower pace - in many euro area countries.
Manufacturing output in Japan and the US is still at a very low level. Despite the pickup in
growth, capacity utilisation in advanced economies will remain very low for the next two-three
years.
Uncertainty in equity markets has eased and risk premiums are lower, reflected in a rise in
leading US stock indices of more than 50 per cent since equity markets bottomed out at the
beginning of March 2009. Oslo Børs has risen by about 70 per cent since the beginning of
March.
The price of oil has risen somewhat since the June Report, and has doubled since the trough
in December 2008. Metals prices have also risen. The increase in oil prices reflects low
growth in oil production, more positive expectations as to the world economy and a weaker
US dollar.
On the other hand, OECD oil inventories are still ample and OPEC spare production capacity
is higher than in the preceding years, while oil demand remains weak.
Key rates are close to zero in many countries. Several central banks have signalled that key
rates will be kept low for a long period, and key rate expectations abroad have fallen. Pricing
in the market indicates an expected rise in key rates in a number of countries after the turn of
the year.
The krone depreciated considerably in the second half of 2008, but has since appreciated
again. Stronger risk appetite and market expectations of a somewhat earlier rise in interest
rates in Norway have probably contributed to the krone appreciation. Lower capital outflows
from the Government Pension Fund - Global have probably also made a contribution.
Trading in NOK has picked up since summer and foreign exchange market liquidity has
improved.
The projections are based on the assumption that the krone will depreciate somewhat from
the current level. It is for example assumed that the real krone exchange rate will gradually
revert to its historical average.
The krone is floating and fluctuates somewhat. It has shown a tendency to appreciate in
favourable times and fall in value in response to negative shocks in the Norwegian economy.
Nonetheless, budgetary policy and the petroleum fund mechanism contribute to stability in
the krone, as is clearly reflected in the movements in the krone in recent years compared
with the currencies of other open economies with substantial exports of raw materials, such
as Australia and New Zealand.
The outlook for the Norwegian economy is better than for most other advanced economies.
The rebound in activity will probably occur more rapidly, with inflation maintaining a
somewhat higher level than in many other countries. Monetary policy measures, combined
with petroleum investment and growth in public spending, have boosted activity. The
downturn in the Norwegian economy may be relatively mild.
The Norwegian authorities implemented a range of measures to mitigate the impact of the
crisis on the Norwegian economy. As a result, the liquidity crisis did not turn into a bank
solvency crisis or a crisis in the real economy.
Norges Bank reduced the key policy rate considerably last autumn. The key policy rate has
been reduced further in 2009 to 1.25 per cent. Norges Bank also stepped up its supply of
liquidity to banks in the form of short- and long-term loans. The arrangement whereby banks
could exchange covered bonds (OMF) for government securities made a contribution to
securing long-term funding for banks. Strong growth in government spending fuelled demand
for goods and services.
The authorities supply risk capital to Norwegian banks through the Norwegian State Finance
Fund to strengthen banks' solidity. The Government has also provided increased loans and
guarantees to Norwegian export industries, and has raised lending limits for state banks. In
addition, Folketrygdfondet (the Government Pension Fund - Norway) has been permitted to
increase its purchases of bonds.
The extraordinary monetary and liquidity measures implemented were tailored to a situation
in which financial markets no longer functioned. In Norway, it has been appropriate to start
winding down the unconventional measures earlier than in other countries:
In recent months, Norges Bank has not supplied liquidity through the currency swap lines or
liquidity in foreign currency.
Loans in NOK at long maturities have not been provided since February.
Surplus liquidity in the banking system was increased to more than NOK 100 billion, but is
now close to a more normal level. This motivates banks to revert to money market funding.
The swap arrangement involving covered bonds (OMF) in exchange for government
securities has made an essential contribution to securing banks' long-term funding. The first
signs that the covered bond market was beginning to function appeared in spring. The
minimum price in the swap arrangement has been raised by 0.9 percentage point, from
NIBOR-0.2 percentage point to NIBOR+0.7 percentage point. Use of the arrangement is
currently being phased out.
Norges Bank eased its collateral requirements to enable banks to increase their borrowing in
the central bank. This measure is now being reversed.
Norges Bank has also announced that the share of a bank's borrowing facility that can be
based on collateral in the form of bank bonds will gradually be reduced. Covered bonds will
continue to be eligible as collateral.
Mainland GDP increased in Q2 after two quarters of negative growth. Growth was somewhat
higher than expected, reflecting solid growth in public sector demand and private
consumption. In September, Norges Bank's regional network contacts reported that activity
had edged up in Q3. The main contribution came from industries providing goods and
services to households and the public sector.
Despite a moderate rebound in both domestic and international activity, prospects for
manufacturing and the building and construction sector remain relatively weak. After falling
for a long period, manufacturing production picked up again in July and August.
The decline in new orders and order reserves, in the shipbuilding industry among others,
nevertheless indicates a low manufacturing production level in the period ahead. According
to the regional network, manufacturing production is expected to remain unchanged over the
next half-year. Overall production in the building and construction sector is also expected to
remain virtually unchanged, with increased activity in the construction sector underpinning
production. Enterprises in the service sector expect production to pick up over the next
halfyear. Regional network enterprises in the retail sector report that production is rising and
expect continued growth ahead.
The petroleum sector is having a stabilising effect on overall demand via new investment,
maintenance and operations. Petroleum investment has increased considerably in recent
years, but is projected to fall somewhat towards the end of 2009. According to the petroleum
investment intentions survey from Statistics Norway, petroleum investment will remain high in
2010. Exploration and production spending appear to be increasing markedly, but the
increase will to some extent be offset by reduced spending on goods and services for field
development and fields in operation. The change in investment composition will contribute to
reducing demand for goods and services from the Norwegian supplier industry.
Several investment projects are planned on the Norwegian continental shelf for the coming
years. There are indications that some of the planned investments will require an oil price of
around USD 70 per barrel to be profitable. Our projections are based on a rise in the oil price
in line with oil futures prices. These prices suggest that the oil price in 2010 and 2011 will be
USD 5-10 above the current level. Petroleum investment is therefore projected to be high in
the period 2010-2012.
Should the global growth outlook deteriorate again, the price of oil may fall markedly. This
might lead to a decline in oil investment and also have an adverse impact on the wider
Norwegian economy. On the other hand, a fall in oil prices normally results in a depreciation
of the krone. Should the krone depreciate for an extended period, inflation may become too
high. With lower oil prices, the economic outlook will deteriorate, but the overall effect on
inflation of a marked fall in oil prices and a weaker krone is not clear cut.
The sharp decline in activity among trading partners has reduced demand for Norwegian
export products. The decline in Norwegian exports has occurred slightly later and been
somewhat more moderate than observed in a number of other countries. After a sharp fall in
exports in the first half of 2009, foreign trade statistics indicate that traditional merchandise
exports have increased somewhat this autumn. Norges Bank's regional network reports that
the export industry is expecting approximately unchanged activity over the next half-year.
The cost level in the Norwegian business sector is now about 15 per cent higher than the
average for the period since 1970, measured in terms of relative wages in a common
currency. Since wage growth is higher in Norway than abroad, relative costs will rise ahead
even if the nominal krone exchange rate should remain unchanged. This will put many
Norwegian firms in a demanding position in terms of international competition, which may
influence location decisions ahead. Export growth is expected to pick up ahead, but at a
slower pace than expected market growth abroad.
The contraction in private investment has been somewhat more moderate in Norway than in
a number of other countries over the past year, even though business investment also
dropped sharply in Norway. Corporate credit growth is slowing, but Norges Bank's
thirdquarter bank lending survey indicates that enterprises' access to bank credit has improved
and that this tendency will continue in 2009 Q4. At the same time, borrowing in the bond
market has become more accessible and less costly. The decline in business investment will
probably come to a halt in the course of 2010 as growth recovers, funding conditions improve
further and interest rates remain low. Banks' tightening of credit standards has been less
pronounced for households than for enterprises. All the banks participating in Norges Bank's
lending survey expect credit standards for households to remain unchanged ahead.
Lower interest rates in the period to summer and easier access to residential mortgage loans
have fuelled housing demand. House prices have shown a seasonally adjusted increase of
approximately 14 per cent since the trough in November 2008, and the decline in household
credit growth has levelled off. Housing investment may start to increase towards the middle
of next year.
Interest rates in Norway are low. This has led to renewed growth in household consumption,
and there are prospects that household demand will continue to rise. According to surveys
carried out by TNS Gallup and Opinion, household expectations with regard to the outlook
ahead are more optimistic now than they were in autumn 2008. In addition, housing wealth
has improved as a result of higher house prices, which may underpin growth in consumer
spending.
We have limited experience to indicate how the interest rate at the current low level will affect
output and prices over time. If growth in household demand proves to be stronger than
expected, the interest rate may be raised to a higher level and more rapidly than currently
envisaged.
Fiscal policy is expansionary this year, and according to the National Budget for 2010, fiscal
policy will provide further, albeit milder expansionary impulses to the economy next year.
Under the fiscal rule, the government budget deficit should be reduced to about 4 per cent of
the capital in the Government Pension Fund - Global when activity in the economy has
resumed a normal level. Norges Bank's projections are based on the technical assumption
that the structural, non-oil budget deficit in 2011 and 2012 will remain unchanged from the
level in 2010. If growth in the Government Pension Fund - Global is lower than in previous
years, the deficit will still be more than 4 per cent of the Fund's capital, even after capacity
utilisation has risen to a normal level. If economic developments are broadly in line with
projections, fiscal policy conducted in accordance with the fiscal rule could result in a lower
interest rate and a weaker krone than projected.
Unemployment is high in many countries. Unemployment in Norway has not risen as sharply
as previously projected. The number of registered unemployed was 2.8 per cent of the labour
force in October, unchanged from September. This is very low compared with other
countries.
The decline in employment has been less marked than the fall in activity would imply.
Unemployment may be low partly because it may have taken time for enterprises to adapt
their workforces to the sharp fall in production, and partly because some enterprises have
decided to maintain their workforces in anticipation of a pickup in demand. In many sectors,
the level of employment is nevertheless high in relation to output, and productivity in the past
year has been at its lowest level since 1988.
The projections are based on the assumption that productivity will gradually improve,
reducing the pressure on firms' costs somewhat. The projections are also based on improved
profitability through an increase in prices. If firms instead reduce employment more rapidly
and markedly in order to improve productivity, that will lead to higher unemployment and
lower wage and price inflation than projected. The interest rate may then be kept lower for a
longer period than currently envisaged in order to ensure that inflation returns to target.
Wage growth is projected to decrease to around 4 per cent in 2009. Weak manufacturing
profitability as a result of both a fall in product prices and a low productivity level suggest
moderate wage growth ahead. At the same time, wage growth among trading partners is low.
As a result, the competitiveness of internationally exposed industries may weaken further in
the period ahead. In isolation, this may contribute to curbing wage growth. On the other
hand, continued relatively low unemployment in Norway will contribute to pushing up wage
growth. Wage growth is projected to increase to 41⁄4 per cent in 2010, rising further to 43⁄4 per
cent towards the end of the projection period.
The severe cyclical downturn and the decline in commodity prices have resulted in very low
consumer price inflation in many countries. The year-on-year change in consumer prices is
negative in the US, the euro area, Sweden, Japan and China. Core inflation is more stable,
but has also edged down recently. Moderate growth prospects and lower-than-normal
capacity utilisation in most advanced economies will lead to low consumer price inflation
among our main trading partners throughout the projection period.
The key policy rate was reduced to prevent inflation from falling too far below target and to
mitigate the impact of the global downturn on the Norwegian economy. Underlying consumer
price inflation in Norway has slowed in recent months to an estimated rate of just below 21⁄2
per cent, reflecting the effects of lower wage growth, reduced capacity utilisation in the
Norwegian economy and low inflation abroad. Although the krone depreciation last autumn
has pushed up import prices, the effect of the depreciation is probably now waning.
After a period of falling productivity, unit labour costs are high. The projections are based on
an increase in firms' margins ahead through an increase in prices. Inflation will nevertheless
be curbed by slower wage growth from 2008 and a gradual rise in productivity growth.
Somewhat further ahead higher wage growth will push up the rise in prices. The krone
exchange rate has appreciated from weak levels. Combined with the fall in prices for
imported consumer goods measured in foreign currency, this will push down the rise in
prices for consumer goods in the short term.
Consumer price inflation is expected to fall to somewhat below 2 per cent in 2010, and then
gradually pick up to around 2.5 per cent towards the end of the projection period.
Interest rates are low, resulting in renewed growth in household consumption. At the same
time, house prices are rising. Over time, household borrowing may surge again and saving
may fall. With low productivity, higher corporate costs, growth in household demand and
higher capacity utilisation, inflation may gradually become too high. This would indicate that
the interest rate should be raised.
On the other hand, a marked increase in the interest rate in Norway and a wider interest rate
differential between Norway and other countries may entail a risk of a
stronger-thanprojected krone, resulting in an inflation level that is too low. This would indicate that the
interest rate should not be raised too rapidly.
Monetary policy cannot fine-tune developments in the economy, but it can mitigate the most
severe effects when the economy is exposed to shocks. Overall, the outlook and the balance
of risks suggest that the key policy rate should be gradually increased in the period ahead.
The projections are uncertain. New information may reveal aspects of economic
developments that suggest the Norwegian economy is following a different path than
projected. Higher capacity utilisation or a weaker krone may, on the one hand, result in
higher-than-projected inflation. On the other hand, inflation may be lower than projected if the
krone remains strong or productivity picks up more rapidly. Should the krone appreciate
considerably more than projected, the interest rate may be increased to a lesser extent or
later than currently envisaged.
The key policy rate should be in the interval 11⁄4-21⁄4 per cent in the period to the publication
of the next Monetary Policy Report on 24 March 2010 unless the Norwegian economy is
exposed to new major shocks.
Thank you for your attention.