Ukraine war creating uncertainty in growing Norwegian economy

In 2021, almost the entire downturn in economic activity during the pandemic was recovered. Activity in November was close to what is considered a normal level for the economy, but the outbreak of the Omicron variant of the virus before Christmas led to a fall in mainland GDP of 1.5 per cent for December and January combined.

‘The end of the infection control measures at the beginning of February alone indicates a further marked upswing in economic activity. Going forward, increased oil investments, consumption and exports will boost growth in the Norwegian economy,’ says Statistics Norway researcher Thomas von Brasch.

However, the war in Ukraine is significantly diminishing growth prospects for Norway’s trading partners, which in turn will also put a damper on the Norwegian economy. The international economy is being hit by high energy prices and bottlenecks in the production of goods and services, and the sanctions against Russia are exacerbating the situation.

‘Our forecasts estimate growth in mainland GDP of 3.6 per cent this year, before falling to around 2 per cent for the remainder of the forecast period. We have made a downward adjustment to growth since our December forecasts, due to both the outbreak of Omicron and the war in Ukraine,’ says von Brasch.

Norges Bank is expected to raise its key policy rate four times this year, and once next year. This means that the interest rate will rise to 1.75 per cent in 2023. The higher interest rates will also curb activity in the longer term.

‘Overall, we estimate that the Norwegian economy will be almost cyclically neutral in the years ahead. This means stable moderate growth, and a normal level of unemployment,’ says Thomas von Brasch.

The forecasts assume that the war in Ukraine will be over in a couple of months. If this assumption is not realised, the ramifications for the Norwegian economy could be worse than estimated.

‘The uncertainty about economic developments in Norway is now extraordinary. We assume that the international bottlenecks are temporary, but there is of course great uncertainty about how the war in Ukraine will unfold, and what the consequences will be,’ says von Brasch.

In text box 2.1 of the forecast report, Statistics Norway has included an alternative calculation for how the Norwegian economy will be impacted if the war becomes more protracted.

Higher energy prices driving inflation

Rising energy prices pushed up inflation to 3.5 per cent last year. The war in Ukraine has led to further increases in energy prices, which will mean strong inflationary impulses this year as well. Bottlenecks in the production of goods and services that characterise the international economy are pulling in the same direction.

In 2022, growth in the consumer price index (CPI) is estimated at 3.3 per cent.

‘The stronger krone and the government’s electricity support programme is reducing the increased price pressure. Without the electricity support programme, the growth would have been as much as 4.5 per cent,’ says von Brasch.

A considerable increase was seen in food prices and non-alcoholic beverage prices between January and February this year. As a result of the war in Ukraine, food prices are expected to continue to rise globally, which will also lead to higher prices in Norway in the coming months.

‘Russia and Ukraine are two of the world’s largest wheat exporters. According to the UN, food prices could rise between 8 and 22 per cent from current levels due to the fall in production. Norway’s agricultural policy means that consumers will not have to bear the full brunt of international price increases, but if the situation was to persist, we can probably expect a continued rise in food prices,’ says von Brasch.

Lower electricity prices will drive down CPI growth to 1.8 per cent in 2023, and this will remain at around 2 per cent in 2024 and 2025 – roughly at the target inflation rate.

Higher real wage growth in the years ahead

The annual wage growth in 2022 is estimated at 3.6 per cent, which is slightly higher than the estimated inflation.

‘It appears that real wage growth will remain temporarily low this year. Last year, real wages were unchanged, and this year the war in Ukraine and the poorer international outlook will affect the earning capacity of many of the wage-leading industries,’ says von Brasch.

‘In the years ahead, however, we expect real wage growth to increase. Lower energy prices will push down inflation and improve the profitability of the wage-leading industries,’ he continues.

The nominal annual wage growth is estimated at just under 4 per cent in 2023, and inflation will be lower. In this scenario, real wage growth will be around 2.0 per cent throughout the period 2023 to 2025.

High-pressure labour market

Unemployment as measured in the Labour Force Survey (LFS) is now lower than average for the ten-year period 2010-2019. The average unemployment rate in the three-month period from November 2021 to January 2022 was 3.3 per cent.

‘The end of infection control measures in Norway will enable industries that have not yet recovered to return to normal levels of activity. However, the negative impulses in demand in the international economy as a result of the war in Ukraine will put a damper on employment developments here at home,’ says von Brasch.

In 2022, the LFS unemployment rate will be 3.5 per cent as an annual average, according to the calculations. Labour immigration is expected to increase gradually, which will alleviate the pressure in the labour market. In 2023 and 2024, estimated unemployment will be around 3.7 per cent.

Slower recovery in the international economy

The invasion of Ukraine and the subsequent sanctions against Russia and Belarus have curbed the prospects of a continued strong global economic recovery. International forecasts have therefore been revised downwards since the last report, based on the assumption that the war will be over relatively quickly.

‘The danger that the conflict will escalate and develop into a large-scale war in Europe clearly exists,’ says Statistics Norway researcher Roger Hammersland.

‘Combined with the risk of new resistant mutations of the coronavirus emerging, and a monetary policy that may be tightened too much, this is creating a downside risk,’ he adds.