High inflation and higher interest rates set to curb growth in the Norwegian economy

The Norwegian economy has recovered from the pandemic. In March, mainland GDP was just below trend, and unemployment is at its lowest since before the financial crisis in 2008. Going forward, the increase in activity is expected to continue. Statistics Norway estimates 3.7 per cent growth in the mainland economy this year.

‘We are heading into an economic boom. Meanwhile, we have record-high inflation, which suggests that the key policy rate will be raised relatively quickly,’ says Statistics Norway researcher Thomas von Brasch.

In May, the twelve-month growth in the consumer price index (CPI) was 5.7 per cent, which is the highest recorded by Statistics Norway since 1988. Inflation is now estimated at 4.7 per cent for the year as a whole, which is an upward adjustment of 1.4 percentage points from Statistics Norway’s forecasts in March. The interest rate path has also been raised significantly.

‘Inflation is high and price increases are more widespread than a few months ago. We therefore estimate that Norges Bank will raise its key policy rate by 0.5 percentage points in June, and a further 0.25 percentage points in both September and December,’ says Thomas von Brasch.

There are also signals internationally that high inflation and consequently higher interest rates will curb the strong growth that has so far been seen. This will have a knock-on effect on the Norwegian economy.

‘The combination of interest rate increases and expectations of lower international growth will curb activity in the Norwegian economy going forward. Consequently, the economic boom we are heading into will not be particularly strong, and we anticipate moderate growth in the years ahead,’ says Thomas von Brasch.

Growth in the mainland economy is expected to slow to just under 2 per cent in 2025.

Without the impending interest rate increases, inflation would probably have remained higher than the target inflation rate, and the Norwegian economy would have experienced a more significant boom than forecast. Statistics Norway has made a separate calculation of what the interest rate increases will mean for the Norwegian economy.

Key policy rate of 2.5 per cent in 2023

After well over a year with a record low zero interest rate policy, Norges Bank has raised the interest rate three times since September last year to the current 0.75 per cent. This is still significantly lower than what the central bank considers a normal interest rate level. A normal money market interest rate is estimated to be around 2 per cent.

With a further three interest rate hikes this year totalling one percentage point, the key policy rate will rise to 1.75 per cent, before being raised further next year.

‘We estimate that the key policy rate will rise to 2.5 per cent in 2023, and then remain at this level. Against this backdrop, a typical mortgage rate will rise from around 2 per cent in 2021 to around 4 per cent in 2025,’ says Thomas von Brasch.

New factors driving inflation

Last year, higher energy prices resulted in a 3.5 per cent growth in the CPI. So far this year, the twelve-month growth in the CPI has increased every month.

‘Further increases in energy prices resulting from the war in Ukraine mean strong inflationary impulses this year as well. Bottlenecks in the production of goods and services that characterise the international economy are pushing in the same direction,’ says Thomas von Brasch.

‘The upward adjustment of the inflation estimate for 2022 by 1.4 percentage points to 4.7 per cent is mainly due to the depreciation of the krone and the fact that future markets for electricity and crude oil indicate higher prices than previously assumed. In addition, prices on the international market, excluding energy goods, have also increased more than anticipated,’ says Thomas von Brasch.

Inflation is expected to decline in the years ahead. Slightly higher productivity growth and lower electricity and crude oil prices will push CPI growth down to around 2.5 per cent in 2023 and close to the target inflation rate of 2 per cent in 2024 and 2025.

Fall in real wages this year, despite the high-pressure labour market

Unemployment as measured in the Labour Force Survey (LFS) has fallen by around 2 percentage points in one year, and was 2.9 per cent on average in the period from February to April. This is the lowest level since before the financial crisis in 2008.

The parties to the centralised wage bargaining agreed on a wage increase of 3.7 to 3.8 per cent this year. However, wage growth is likely to increase more than this due to the high-pressure labour market.

‘We estimate an annual wage growth of 4 per cent in 2022. However, the upward adjustment of estimated inflation to 4.7 per cent means a fall in real wages this year,’ says Thomas von Brasch.

Real wages are expected to increase in the years ahead. Annual wage growth is expected to remain at around 4 per cent in 2023 and 2024, which will lead to real wage growth of just under 2 per cent on average over these two years.

House price growth of 5.8 per cent this year

House price growth is expected to be moderate in the years ahead. In 2021, house prices increased on an annual basis by as much as 10.5 per cent, but the growth rate slowed throughout the year.

Statistics from Real Estate Norway (Eiendom Norge) show that house prices have increased further, by almost 5 per cent in the first five months of 2022. The rise in prices so far this year must be viewed in conjunction with the new, more stringent regulations for house sales introduced this year – which include a requirement for a more exhaustive property report – and the resulting shortage of properties in the housing market.

The number of homes for sale increased in May, and in the slightly longer term, the supply of homes is expected to increase further as a result of the higher housing investment.

‘The increased supply of housing in combination with higher interest rates is curbing house price growth, and real house prices are therefore likely to fall slightly in the years ahead,’ says Thomas von Brasch.

‘Overall, house price growth is estimated at 5.8 per cent this year. This assumes that house prices will increase by 1 per cent throughout the rest of the year,’ says Thomas von Brasch.

Due to the expected higher interest rate path, the forecasts for house price developments have been adjusted downwards from next year. It is assumed that annual house price growth will fall from 2.6 per cent in 2023 to about 1 per cent in the years 2024 and 2025. In this scenario, real house prices will fall every year in the period 2023–2025.

International economy

‘The international economy is dominated by the war in Ukraine, global supply chain problems, weak demand and closed ports in China, as well as a worldwide cost of living crisis,’ says researcher Roger Hammersland.

In the forecasts for the international economy, inflation in the euro area is higher than in the forecasts from March. After a period of strong economic recovery among our trading partners, several countries are now facing a shift in growth. With growth of 5.9 per cent in 2021, falling to 3 per cent and 1.8 per cent in 2022 and 2023 respectively, economic growth among our trading partners is expected to be weaker than forecasts from March.

The downward revision of the growth estimates means that the activity development of our trading partners can be characterised as cyclically neutral throughout the forecast period.