Weak krone means another year of real wage decline

The weak krone is having a major impact on the Norwegian economy. In 2022, EUR 1 cost between NOK 9.40 and NOK 10.60. In early June this year, the corresponding price was NOK 11.90. Statistics Norway’s forecasts assume no change in exchange rates going forward, which will mean a record weakening of the krone this year.

Although inflation measured by the Consumer Price Index (CPI) has decreased since the peak in October last year, the increasingly weak krone means that it will take longer than previously assumed for inflation to reach the target inflation rate.

‘The weak krone makes inflation more persistent. Imported goods become more expensive, which prolongs high inflation’, says Statistics Norway researcher Thomas von Brasch.

Statistics Norway’s new forecasts estimate that average CPI growth for 2023 will be 5.6 per cent. This is 0.6 percentage points higher than in the previous forecast report in March. CPI adjusted for tax changes and excluding energy products (CPI-ATE) is estimated at 6.0 per cent.

‘We assume an annual wage growth of 5.3 per cent this year. With the expected 5.6 per cent inflation, this means that real wages will fall slightly this year as well’, says Thomas von Brasch, adding that there has hardly been any real wage growth since 2015.

Growth in inflation measured by the national accounts deflator for household consumptionThere are several factors that give rise to differences between the CPI and the consumption deflator in the national accounts. The two indexes are weighted differently, and most consumption groups in the national accounts are deflated using relevant sub-indexes in the CPI, but for some domestically produced services, the deflator in consumption is linked to price developments in production. This applies to, inter alia, financial services and FISIM. In addition, the national accounts include household consumption abroad, which is not included with separate price observations in the CPI. For a detailed description of the differences between the consumption deflator in the national accounts and the CPI, see Box 3.2 in Economic Survey 1/2023.Lukk, which includes the rise in inflation for Norwegians’ consumption abroad, is estimated at almost 7 per cent for 2023. This further points to a decline in real wages.

Interest rate peak of 3.75 per cent this autumn

The impact of the weak krone on inflation means that Norges Bank is likely to raise the key policy rate further from the current level of 3.25 per cent.

‘We estimate that the central bank will raise the interest rate by 0.25 percentage points in both June and September, giving a peak interest rate of 3.75 per cent in the autumn’, says Thomas von Brasch.

So far this year, growth in the Norwegian economy has slowed slightly, but mainland GDP is close to what Statistics Norway considers to be the trend level. This trend is expected to continue in the years ahead, with annual growth of around 1.7 per cent.

Higher interest rates and slowing inflation abroad will gradually help to reduce inflation in Norway. Our estimates show that inflation will fall to 3.0 per cent in 2024, and approach the target inflation rate of 2 per cent in 2026.

A gradual rise in unemployment may also provide scope to reduce the key policy rate as early as 2024.

‘If there are no further disruptions in the economy going forward, we will finally see real wage growth in 2024’, says Thomas von Brasch.

Economic policy put to the test

The weak krone means that it will take longer for the central bank to reach the inflation target rate.

‘The record weak krone is putting parts of Norway’s economic policy to the test’, warns Thomas von Brasch.

Increasing profitability in parts of the wage-leading tradable sector as a result of a weaker krone could ramp up wage and price pressure if this is quickly converted to higher wage growth.

In addition, the fiscal policy possibilities increase as the value of the soverign wealth fund (measured in Norwegian krone) rises.

‘For short-term political reasons, it can therefore be tempting to increase the petroleum revenue spending significantly in the years head’, says von Brasch.

However, if the krone remains at its current level, as forecast by Statistics Norway, both fiscal policy and the social partners will most likely adapt to the weakening krone over several years.

See box 2.1 in the full report for a closer analysis of these possible scenarios.

Gradually rising unemployment

Uunemployment, as measured by the Labor Force Survey (LFS), was around 3.1 per cent at this time last year, while in recent months it has been around 3.5 per cent. This is still relatively low from a cyclical perspective.

With weaker growth prospects internationally, rising interest rates and lower demand in many industries, labor market pressure will ease. Employment is thus not expected to increase as much as the growth in the working age population, and the share in employment will therefore fall slightly.

‘The high pressure in the labour market seems to be easing. According to our calculations, unemployment will continue to rise gradually in the years ahead, to around 4 per cent in 2025’, says Thomas von Brasch.

Lower fall in house prices than previously expected

House prices have been rising more than anticipated in 2023. The monthly house price index from Real Estate Norway (Eiendom Norge) shows that second-hand house prices have continued to rise after the fall in prices last autumn, despite frequent mortgage rate hikes over the past year.

‘We expect that higher interest rates and lower disposable real income will curb house price growth slightly in the remainder of 2023, such that house prices as a year average will fall by around one and a half per cent’, says Thomas von Brasch.

From the peak in the second quarter of 2022 until the expected bottoming out towards the end of 2023, a house price drop of between 6 and 7 per cent is now anticipated.

Weak growth in consumption this year

Household consumption, which makes up around half of mainland GDP, grew a substantial 6.9 per cent last year, despite the high price growth for a number of goods and services.

According to the forecasts, growth in disposable real income will increase from 2024 as a result of higher wage growth and falling inflation, but this will be tempered by weak developments in real house prices.

Higher disposable real income will push up consumption growth from around 0.5 per cent this year to around 3 per cent in 2026. The savings rate will increase through the projection path from a low level in 2023.

International economy

Many of Norway’s trading partners are experiencing a difficult economic situation.

‘Although the economic outlook is close to neutral for the countries as a whole, there is still a high probability that some of them will end up facing an economic downturn’, says Statistics Norway researcher Roger Hammersland.

Germany is already in a technical recession, and there are strong indications that the United States may soon follow suit.

The forecasts indicate a slowdown in economic growth in the short term, but activity will nevertheless remain at near-trend level among Norway’s trading partners as a whole in the years ahead.

‘However, there is a major downside risk, and the central banks are facing the difficult task of stabilising inflation whilst also ensuring financial stability. A monetary policy that is too restrictive could, under such circumstances, quickly trigger a new crisis’, says Roger Hammersland.