Norway Lifts Benchmark Rate, Signals More Increases

Norway Lifts Benchmark Rate, Signals More Increases

Oct. 28 (Bloomberg) -- Norges Bank raised its key interest rate a quarter point from a record low and signaled steeper increases than it previously forecast over the next three years as inflation accelerates and unemployment remains low.

The Oslo-based bank raised the overnight deposit rate to 1.5 percent, becoming the first European central bank to reverse its easing cycle since the credit crisis started to abate. Nineteen of 20 economists surveyed by Bloomberg had predicted the move, while one had expected a half-point increase.

“It appears that unemployment over the next few years will remain lower and wage growth somewhat higher than previously projected,” the bank said in a statement. “This suggests higher inflation, indicating that the key policy rate should be raised somewhat more rapidly than previously projected.” The key rate will average 4.25 percent in 2012, compared with a June forecast for 3.75 percent, the bank said.

The world’s fifth-biggest oil exporter came out of recession in the second quarter after investment in its petroleum industry, a stimulus package equivalent to 4.7 percent of gross domestic product and record-low borrowing costs fueled domestic demand. Prime Minister Jens Stoltenberg, whose coalition government was re-elected last month, has pledged to raise next year’s spending in excess of national fiscal guidelines even after recovery took hold.

Economic Outlook

The krone was trading 0.2 percent lower against the euro at 8.3781 at 2:50 p.m. in Oslo after having lost as much as 1.1 percent earlier in the day.

“Norway’s huge oil surplus and supportive fiscal policy have helped to insulate the economy from the worst of the global economic downturn,” Ben May, an economist at Capital Economics in London, said in a note. “Accordingly, it is unlikely that other central banks in the region will follow suit and hike rates any time soon. What’s more, we doubt that today’s hike will mark the start of an aggressive tightening of monetary policy in Norway itself.”

The bank expects underlying inflation, which adjusts for energy and taxes, to average 2.75 percent this year and 1.75 percent in 2010. The mainland economy will shrink 1.25 percent this year and grow 2.75 percent in 2010, it estimates.

The key rate will average 1.75 percent this year and 2.25 percent in 2010, rising to an average 4.25 percent by 2012, the bank said.

Not Aggressive

“This is by no means an aggressive path,” said Harald Magnus Andreassen, chief economist at First Securities ASA in Oslo. “Norges Bank looks to take quite a long time to come back to normal rates.”

A “natural” key interest rate level is 5 percent, Governor Svein Gjedrem said on Sept. 25. The benchmark was last at that level in October last year.

Gjedrem “has to take into account that fiscal policy is very loose,” said Torgeir Hoien, a former Norges Bank external board member who manages the equivalent of 2 billion kroner ($350 million) in bonds at Skagen AS.

Fiscal stimulus has helped keep Norway’s jobless rate the lowest in Europe, with registered unemployment falling to 2.7 percent in September. Survey unemployment was 3.2 percent in the August quarter, Statistics Norway said today.

Benefits

Households were quick to benefit from monetary easing earlier this year, with about 90 percent of mortgage holders using floating rates, according to the Finance Ministry. That’s boosted demand, with retail sales rising in the last three months for which data are available.

Cheap loans and low unemployment have helped push the housing market up in the last three quarters, with prices now matching their peak from the summer of 2007, the Finance Ministry estimates.

“The strong boost to households’ disposable income and relatively low unemployment rates have had significant effects on the housing market, home prices have topped the pre-crisis peak levels,” Bjoern-Roger Wilhelmsen, senior economist at First Securities in Oslo and a former Norges Bank economist, said in a note to clients yesterday.

While signs of a strong recovery may support a rapid reversal of monetary easing, the central bank must balance the needs of the domestic economy against the prospect of hurting exporters by spurring gains in the krone, economists have said.

‘Overshooting’

“If they don’t do anything about it, you will have an overshooting of the inflation target,” Hoien said. “If they adjust monetary policy to the fact that fiscal policy is very loose, you will get a stronger krone.”

The krone has gained 7 percent against the euro since the end of June, making it the second-best performer of the 16 major currencies tracked by Bloomberg in the period. A further strengthening would hurt exporters including Norsk Hydro ASA, Europe’s third-largest aluminum producer, and Norske Skogindustrier ASA, the world’s second-biggest newsprint maker.

Exports will recover more slowly than consumer demand, the government forecasts, rising 0.1 percent in 2010 after slumping 6.5 percent this year.

The bank uses policy to target consumer price gains of 2.5 percent. Inflation was 2.4 percent last month, adjusting for the effect of taxes and energy. This year, the rate has exceeded the central bank’s target in six out of nine months.

“Since the last monetary policy meeting in September, economic data, on average, were stronger than market expectations,” Gizem Kara, an economist at BNP Paribas in London, said in an Oct. 9 note after the inflation report.

Gjedrem said on Sept. 30 that asset prices “have risen sharply and probably excessively,” characterizing policy rates as “extremely low.

Gjedrem is the third central bank chief to raise rates this year after the Bank of Israel lifted its lending rate a quarter point in August and Australia’s Reserve Bank raised its overnight cash target rate by 0.25 point this month.

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