As widely expected, the Norges Bank decided to raise the official interest rate by 25bps to 4.50%. The reason behind the rate hike, according to Citigroup Research is a combination of strong economic activity, a tight labour market with intensifying wage pressures and expectations of increasing cost pressures in the economy.
In the June Monetary Policy Report, the Norges Bank reiterated its view of strong economic prospects for
On the inflation front, the Norges Bank reiterated that consumer price inflation remains moderate at present, but that some of the driving factors that have curbed inflation so far may gradually lose momentum from the beginning of next year. Besides the effect from higher electricity prices next year, the Norges Bank emphasized continued high capacity use in conjunction with an expected smaller decline in prices for imported goods, as factors which is expected to lead to higher inflation ahead. Moreover, the central bank referred to the increasingly tight labour market conditions in
Judging from the tone of the report, the Norges Bank appears a bit concerned about the risks of overheating medium term, note Citigroup analysts. The combination of strong economic growth, a tighter labour market, expectations of rising inflationary pressures and a more expansionary fiscal policy was the main argument behind raising the interest rate path today. The central bank now sees the sight deposit rate at around 5.25% by the end this year (5.0% previously) and 5.75% by end Q2-Q3 2008 (5.25%).
The revisions to the Norges Bank macro economic forecasts were more or less in line with Citi Economic Analysts’ expectations, whereas the new interest rate profile for 2008 was somewhat more aggressive. Citi economists had expected to see an interest rate path revision of the end-2007 level from 5.0% to 5.25% and from 5.25% to 5.50% by mid-2008 with risks to the high side. Given the hawkish tone in the report, Citi analysts have decided to revise up their rate forecast to 6.0% by late-2008 (but we may get there sooner), i.e. a bit above the Norges Bank’s own rate profile, but still well below the bank’s high-inflation scenario (where the interest rate is seen at 6.75% in Q4 2008). Here it is also worth remembering that the Norges Bank sees the neutral rate somewhere between 5.0%-6.0%, suggesting that a sight deposit rate of 6.0% is barely contractionary. An interest rate of 6.0% may not even be high enough, if capacity pressures continue to build as rapidly as recently.
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