MNI STATE OF PLAY: Norges Bank Hikes, Ups Rate Forecast

Norges Bank increased its policy rate by 25 basis points at its March meeting and raised its projected rate profile by more than many analysts had expected, leaving the door open to three more hikes than previously anticipated as its forecasts showed inflation above target for the next three years.

The collective rate path showed the policy rate reaching 2.5% by the end of 2023 and staying there in 2024 before dipping in 2025. The previous forecast had the policy rate at 1.75% three years out, suggesting an additional three 25 bps could be on the way, a more hawkish outlook than economists had predicted.

The higher rate path could underestimate the actual pace of tightening, with Governor Ida Wolden Bache stressing following the policy announcement that rates could be raised faster if elevated inflation is persistent.

Norges Bank raised its inflation forecast for each of the next three years, showing it above target throughout the three-year projection. The target CPI-ATE measure was shown at 2.5% in 2022, up 0.8 percentage point from the December forecast, 2.4% in 2023, up 0.4 percentage point and 2.5% in 2024, up 0.5 percentage point, and at 2.4% in 2025. With the target set at 2.0% this suggests scope for the central bank to do even more on the policy rate.

POSITIVE OUTPUT GAP

A key factor in the higher rate profile was the assumption by central bank economists that Norway has run out of spare capacity and will operate in coming years with a positive output gap, as actual output runs above potential.

The central bank’s business survey, its Regional Network Report, highlighted firms’ views that they were operating with no slack and that capacity constraints were at their highest level since before the Global Financial Crisis.

The war in Ukraine was seen having diverse effects, pushing up on inflation but depressing growth in Norway’s trading partners. In its Monetary Policy Report, Norges Bank said its forecasts assumed that the resulting uncertainty would delay some business investment.

As a large oil and gas exporter, however, Norway is largely cushioned from the damaging effects of more expensive energy, with Norges Bank economists noting that higher electricity prices would provide additional government revenue which could trigger higher fiscal transfers than previously assumed, as the state offsets the hit to real incomes.

Unemployment was expected to continue to decline in coming months and employment to rise.