Norges Bank Preview - September 2020: Risk On Steeper Rate Path Projections

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MNINBPrevSep20.pdf

Contents:

- Full MNI Point of View and exclusive policy analysis
- Detailed summary of sell-side analyst views
- MNI Central Bank Datawatch

MNI Point of View: Pinching financial instability risks will be reflected in steeper rate path projections

We expect the Norges Bank to steepen their rate path projections this quarter, although the revisions will be moderate, based on the far-end of the projection curve and may make little difference to the date of the first fully priced rate hike. An inflation rate that has been consistently higher than forecast and the risk of financial instability stemming from surging house prices justify signalling a slightly faster paced tightening cycle at this stage.

Norwegian house prices, both inside and outside Oslo, reached new highs this year as Coronavirus restrictions were eased. While a post-lockdown rise in house prices has been a common theme across the Eurozone, the US and UK, the Norges Bank have explicitly flagged their concerns on bubbly housing in this year's MPRs – most notably in June, where the Bank highlighted that "Historically low lending rates may increase the risk of an acceleration in house price inflation and debt growth".

Figure 1: The Committee will be concerned mortgage rates are projected to fall further

Source: MNI/Norges Bank

The Bank's projections reinforce these risks. In the June Monetary Policy Report, the Bank projected the average mortgage rate to continue to decline throughout 2021 and only pick up well into 2023 – while remaining considerably below the pre-COVID average (See Figure 1). The Bank expect these low rates to feed into further house price appreciation in the coming years, and it's these low rates that may be a cause for concern. The Committee have already flagged financial system vulnerabilities that emerge from house price growth outstripping household income growth over an extended period.

Furthermore, with the Norwegian mortgage market dominated by floating-rate products, the Bank's cumulative 150bps rate cut this year will have buoyed most households mid-mortgage, as well as those seeking new or fixed-rate products, lessening the need for lower rates toward the end of the rate path. A steeper rate path projection would guide these mortgage rates higher across the forecast horizon and alleviate some of these concerns.

Figure 2: CPI-ATE has been consistently above the Norges Bank's June forecast

Source: MNI/Norges Bank

Discounting the financial imbalance risks of accelerating house price growth, the Norges Bank's preferred inflation measure (CPI-ATE) has consistently exceeded their June projections. While this adds to the argument that the Bank should bring forward the timing of rate hikes, the June MPR made it clear that the Committee see the rise in inflation as temporary, feeding through from high import prices as the NOK depreciated throughout Q2. Exchange rates have since stabilised and pressure will mount on the Committee should inflation metrics not begin to moderate from here.

These minor revisions to the rate path projections are unlikely to prompt much response from markets. Since June's tweak to projections, NOK implied volatility has moderated, NIBOR remains subdued and the NOK forward curve indicates few signs of stress. While some of this soothing of markets coincides with an improving COVID caseload, it will give the Committee less cause for concern while indicating a slightly steeper rate path projection this month.