Norges Bank hikes, but worries over financial market unrest

The Norges Bank decided to raise the official interest rate by 25bps to 5.25% at Wednesday’s monetary policy meeting. The move was in line with the indications from the October Monetary Policy Report, according to a report by Citigroup Research.

In the accompanying statement, the Norges Bank justified the rate hike by referring to strong domestic considerations, i.e. stronger than expected growth, rising cost pressures and prospects of a further pick up in inflation, and the latest depreciation of the NOK. However, the statement revealed that the Executive Board actually considered leaving rates on hold amid the heightened uncertainty to the global outlook: ”Since the beginning of November, the turbulence in money and credit markets has regained momentum and the outlook for the world economy has become more uncertain. House prices in Norway have fallen this autumn. Short-term money market rates are considerably higher than expectations concerning key rates would imply. These factors suggest that the key policy rate should be kept unchanged.” We interpret this as a clear signal, that the Bank will keep rates unchanged at the next monetary policy meeting on 23 January (note, there is no meeting in February).

Due to the heightened uncertainty to the global outlook and the strengthening of NOK, the Norges Bank cut its conditional rate path by nearly 40bp in the October Monetary Policy Report, indicating that 5.25% would be the peak level of this strategy period, i.e. until the release of the next Monetary Policy Report on 13 March, but with a 50% probability of a final rate hike in the second quarter of 2008. Neither the press release nor the press conference gave any indications of a change to this strategy.

Citi analysts say they realize that the increasing global growth uncertainty makes the rate outlook next year more uncertain, but maintain their view that the Norges Bank probably will have to continue to normalize monetary policy: The domestic side of the economy continues to surprise on the strong side with the only sector showing signs of weakness being housing. The Norges Bank, though, has long warned about a housing market correction. As such, strong domestic considerations clearly favour a tighter monetary policy stance, and the policy rate is still in the lower range of what the Norges Bank views as neutral (5-6%). “On balance, we stick to our call that rates need to go to 5.75%. As we have emphasized before, though, it might take longer for the Central Bank to get there. So far, we expected rates to reach that level in mid 2008.”