Higher inflation in Norway supports tighter outlook

Inflation is rising in Norway as the economy strengthens and oil prices have hit a three-year high, prompting Norges Bank to bring forward its first planned rate hike to late 2018.

Headline inflation rose year-on-year by 1.6% in December, above the 1.4% forecast by the central bank. But it is still well below the 2.5% target. Volatile factors boosted the increase, according to Statistics Norway. Food sales over Christmas were lower in 2017, which boosted overall year-on-year price rises by 0.2 percentage points. Airfares contributed with an additional 0.3 percentage points.

Norway is enjoying the benefits of higher oil prices after three years of declines, as the energy sector accounts for 25% of the value added in the economy.

“Output growth has picked up somewhat since August. Contacts refer to capacity expansion, productivity improvements and increased demand from export markets,” Norges Bank’s latest regional network report stated in December. “Enterprises also expect marked output growth over the next six months.”

This stronger performance allowed Norges Bank to bring forward its plans for the first rate hike to late 2018.

“The key policy rate is forecast to remain at 0.5% in the period to autumn 2018, followed by a gradual increase to around 1.5% in 2020,” December’s monetary policy report says. “The labour market has improved more than expected and the output gap appears to be somewhat narrower than previously projected. With a key policy rate consistent with the interest rate forecast in this report, the output gap is expected to close in 2019 and be positive in 2020.”

The central bank forecasts wage growth to accelerate from 2.4% in 2017 to 2.9% in 2018, and 3.6% in 2019

Kari Due-Andresen, Handelsbanken

Although inflation in December was higher than expected, the “figure should not change the view of Norges Bank since the jump was not driven by fundamental factors”, says Kjetil Olsen, chief economist at Nordea. “The real test will come [in] the next couple of months, when both the central bank and we expect a further uptick in inflation on the backdrop of the weakening of [the krone] last year.”

The process could also be reinforced by higher taxes.

“The increase in the reduced VAT rate (which affects cinema, public transport, hotel accommodation services and museums among others) on January 1 (from 10% to 12%) will contribute to lift inflation this year,” writes Raphael Brun-Aguerre, senior economist at JP Morgan, in a research note.

Too optimistic for some

Norges Bank expects the sector of the economy unrelated to oil and gas to expand by 2.3% this year. Inflation should rise progressively to 2.1% in 2020. However, this appears too optimistic for some observers.

“The central bank forecasts wage growth to accelerate from 2.4% in 2017 to 2.9% in 2018, and 3.6% in 2019,” Kari Due-Andresen, chief economist at Handelsbanken, tells Central Banking. “We share the view that a tighter labour market argues for higher wage growth, but still view 3.6% in 2019 as too high.”

The central bank may also encounter new obstacles that could force it to postpone the implementation of higher rates. After a decade of rising prices, house prices started to fall in the second half of 2017. In December, prices fell by 2.1% relative to a year earlier.

“The correction in property prices remains the main source of uncertainty for the growth outlook,” say analysts at Morgan Stanley in a note.