Record-high inflation piles pressure on Norges Bank

Inflation in Norway rose by a new record high in July, putting pressure on Norges Bank to deliver a higher interest rate increase at its next monetary policy meeting on August 18.

Last month the core inflation measure CPI-ATE rose year on year by 4.5%, up from 3.6% in June, according to Statistics Norway. Norges Bank uses CPI-ATE as its key measure of underlying price pressures.

The increase in the reading was almost exclusively driven by consumer goods inflation, which rose from 4% in June to 5.7% in July. Price rises in the service sector edged down from 3.4% to 3.3%.

Meanwhile, despite the government’s electricity subsidy scheme, headline inflation increased from 6.3% in June to 6.8% last month, a 34-year high. The central bank’s target is 2%.

In fact, the government’s scheme “is likely to prevent surging wholesale electricity prices from feeding through to the CPI”, says Michael Tran, assistant economist with Capital Economics. “But a tight labour market and high agricultural prices will keep both CPI-ATE and the headline rate way above the Norges Bank’s target for some time.”

In this environment, Capital Economics forecasts the core index will remain between 3.5% and 4% until early 2023.

“Without the [government] scheme, headline inflation would have been 8.9% year on year in July,” says Kjetil Olsen, chief economist Norway with Nordea. “Looking forward, the effects of high energy prices will fade due to base effects and the government’s compensation scheme.”

Olsen thinks this suggests headline inflation will gradually fall in the latter part of the year, while remaining higher than usual.

Tighter strategy

Inflation running well above target is now expected to force the central bank to speed up the ongoing tightening cycle.

In fact, in June’s monetary policy report Norges Bank acknowledged “prospects for a more prolonged period of high inflation suggest a faster rise in the policy rate than projected earlier”.

Back then, the central bank revised up its policy rates assessments to 3% in the period to the summer of 2023. This was deemed to be above the neutral level.

At that meeting, the institution increased the policy rate by 50 basis points to its current level of 1.25%.

Following July’s inflation data, “we think it is increasingly likely that Norges Bank will increase rates by another 50bp next week”, says Tran.

Nordea’s Olsen agrees: “Today’s high core inflation figure clearly argues for Norges Bank to hike rates more quickly.”

He adds: “It gives Norges Bank a clear reason to bring the key rate in Norway faster to a normal level than it indicated in June. The key rate in Norway has clearly been too low for too long.”

Nordea projects a 50bp increase next week. “If not, a September rate hike by 50bp is surely on the cards,” says Olsen.