Interest rate increases on the horizon

Main economic indicators 2011-2024. Accounts and forecasts

To table

In January 2021, the level of activity in the Norwegian economy was 1.5 per cent lower than in February 2020. By the start of March this year, just over 7 per cent of the population had received at least one vaccine dose. According to the Norwegian Institute of Public Health, the numbers vaccinated will increase significantly in the coming months, and it is likely that infection control measures will be eased in May, once the risk groups have been vaccinated.

‘We believe economic activity will see a marked increase this summer, once large parts of the population have been vaccinated and the repercussions of the pandemic have been reduced,’ says researcher Thomas von Brasch.

The consequences of the infection control measures will nevertheless impact on the Norwegian economy for a long time to come, and unemployment is not expected to return to what we consider to be a more normal level until towards the end of 2024. The forecasts show that the key policy interest rate will be raised to 0.25 per cent in the second half of 2021, and then gradually increase to 1.5 per cent by the end of 2024.

Thomas von Brasch explains that a large degree of uncertainty surrounds the further development of the Norwegian economy.

‘We have assumed that many of the measures will be eased in the summer, but this depends on the vaccination programme being successful and infection rates falling. It is also uncertain how well the population will actually continue to follow the stringent infection control measures,’ says Thomas von Brasch.

‘If the stringent measures need to be continued beyond this summer, the economic backlash will last longer than that indicated in our current calculations,’ he adds.

End of international economic downturn in sight

Vaccines and highly expansive economic policies seem to be increasing the prospect of hope becoming reality in relation to future developments in the international economy. As a result, our trading partners’ recovery in economic activity is expected to be somewhat stronger in the years ahead than we previously envisioned.

‘The forecasts are based on the fact that our trading partners are on the verge of a strong and imminent economic upswing. However, the potential transmission of viral mutations that are immune to current vaccines represents a major downside risk,’ says researcher Roger Hammersland, who produces the forecasts for the international economy.

Structural non-oil public deficit remains high

Fiscal policy has helped to reduce the negative impact of the pandemic on the Norwegian economy. In 2020, the Storting passed a number of economic measures and temporary amendments to regulations in order to compensate households and businesses for losses in income. These measures have increased the budget expenditure considerably. In total, the pandemic-related economic measures in 2020 amounted to NOK 131 billion. According to the fiscal rule, petroleum revenue spending over time should amount to 3 per cent of the oil fund, but a large emphasis must also be placed on smoothing out fluctuations in the economy to ensure good capacity utilisation and low unemployment, as was seen in 2020. The structural non-oil public deficit for 2020 in the balanced central government budget for that year is estimated at NOK 392.5 billion. This corresponds to around 3.9 per cent of the oil fund’s market value at the start of the year. For 2021, adopted and proposed pandemic-related measures amount to NOK 65.3 billion. This gives a budget balance of 3.3 per cent, measured by the structural non-oil public deficit as a proportion of the oil fund. In 2022 and 2023, we expect the budget balance to be reduced to about 3 per cent of the oil fund.

Major changes in household consumption during the pandemic

Consumption of services in particular saw a sharp reduction, while most of the consumption of goods recovered quickly after a fall at the start of the pandemic and experienced strong growth in the last three quarters of 2020. Total consumption nevertheless fell 7.6 per cent as an annual average last year. This is the greatest decline in consumption since the time series began in 1970, and historical figures suggest that changes of this nature have not been seen since World War II. Going forward, further growth in service consumption is expected as infection control measures are eased. However, total consumption is not expected to return to the pre-pandemic level until towards the end of 2021 or the start of 2022. With prospects for growth in real disposable income and real house prices, and thus also in real wealth, consumption is expected to grow by around 3 per cent as an annual average over the last two years of the forecast period.

Decline in petroleum investments will gradually reverse

Petroleum companies are reporting reduced investment activity in 2021, but the decline is now much smaller than previously reported. In addition, new development and operation plans are being submitted, which are not included in the oil companies’ figures. We estimate that investments will fall by around 3 per cent this year and 6 per cent next year. The package of tax measures approved by the Storting last year is likely to increase activity in the years ahead. In 2023, petroleum investments are expected to increase by around 10 per cent. This year, the aggregate demand from mainland petroleum investments is expected to boost growth in mainland Norway’s GDP by 0.3 percentage points in 2023. In this scenario, the investment level in 2024 will be roughly in line with the level before the pandemic hit the Norwegian economy, but still more than 20 per cent below the investment peak in 2013. In line with market expectations, we assume that oil prices will gradually decrease from the current level of around USD 68 to around USD 57 by the end of 2024.

Moderate development in business investment

Investment developments last year were strongly impacted by the uncertainty as a result of the coronavirus pandemic, both in Norway and among our trading partners. Many businesses tempered their investment plans and investments fell sharply during the first part of 2020. Manufacturing and power supply companies are also reporting a reduction in investments this year. The service industries have been particularly hard hit by the pandemic. The willingness of businesses to invest has been marked by the major uncertainty about the financial outlook and the lack of financing due to poor liquidity, particularly in the tourism and culture sectors. Overall, we estimate that business investment will fall by around 2 per cent this year. In line with the post-pandemic recovery, investment will increase in the years that follow. According to our calculations, investment growth will be about 3 per cent in 2022, and somewhat less than this in 2023 and 2024.

Strong growth in house prices

Between April 2020 and February this year, house prices rose by 11 per cent, according to Eiendom Norge’s house price statistics. The fact that the key policy interest rate was reduced to 0 per cent last year, in combination with the central bank’s signals that interest rates will remain at this low level for some time, is assumed to be part of the reason for the sharp rise in house prices. The record high savings rate and associated liquidity may also have pushed up house price growth in recent months. We estimate that house prices will rise by around 9 per cent as an annual average in 2021, but there is great uncertainty about future house price growth. House price trends are largely determined by developments in income, debt, population, as well as the supply of housing and real interest rates. The mortgage regulations also play an important role. A moderate increase in mortgage rates in the near future is likely to dampen the house price growth, but house prices will nevertheless continue to rise throughout the forecast period. The high house prices make house-building more profitable. After falling for several years, housing investment is expected to increase towards 2024, by 2 to 4 per cent per annum. Consequently, the level of housing investment in 2024 will be roughly in line with the peak in 2017.

1.5 percentage point increase in key policy rate over next four years

In March last year, the key policy interest rate was cut from 1.5 to 0.25 per cent in two stages, and in May it was set at 0 per cent. In connection with the latest interest rate cut, the central bank signalled unchanged interest rates for several years to come. Norges Bank is now facing some difficult choices. On the one hand, developments in activity suggest that interest rates will be kept at the current level for some time to come. On the other hand, low interest rates lead to higher house prices, which in turn can provide a breeding ground for financial vulnerabilities and imbalances. We assume that the key policy interest rate will be raised to 0.25 per cent during the last half of 2021, and will then gradually be increased to more normal levels. The key policy interest rate is expected to be 1.5 per cent at the end of 2024. This increase in interest rates is slightly higher than what is expected internationally.

Krone remains historically weak

The krone saw a sharp depreciation in the first three weeks of March last year, and Norges Bank took remedial action in the form of a currency intervention. The depreciation has since been reversed to a large extent, but the krone is still weak in a historical perspective. At the start of March this year, one Euro costs NOK 10.2, but for a few days in March last year it was just over NOK 12. We assume that the krone will remain at the level at the start of March this year throughout the forecast period.

Underlying inflation will decline

In 2020, underlying inflation (CPI-ATE) was 3.0 per cent, which was an increase of 0.8 percentage points from 2019. The weakening of the krone and the consequent rise in prices of imported goods contributed to the increase. This year, however, the strengthening of the krone throughout much of last year will push down the growth in the CPI-ATE towards the target inflation rate of 2 per cent. Moderate wage growth and stronger productivity growth will also contribute to this. Our calculations show that the growth in the CPI will be 2.7 per cent this year. While tax changes are expected to reduce CPI growth by around 0.4 percentage points, rising energy prices are likely to push up inflation by around 1.0 percentage point. Inflation measured by both the CPI and the CPI-ATE is expected to edge towards 2 per cent by 2024.

Real wages set to remain unchanged in 2021

In recent years, the nominal annual wage growth has been increasing, from 1.7 per cent in 2016 to 3.5 per cent in 2019. During the pandemic in 2020, annual wage growth was surprisingly high, at 3.1 per cent, and this must be viewed in light of the high wage growth in the 4th quarter and the structural changes resulting from the pandemic. This year, the annual wage growth is expected to be around 2.6 per cent, but with about the same level of inflation, real wages will probably remain unchanged. In 2023 and 2024, the real wage growth is expected to pick up, reaching just over 1 per cent. This is in line with the expected recovery in the Norwegian and international economy. In such a scenario, the labour cost share in manufacturing in 2024 will be approximately on a par with the average for the last 40 years.

Unemployment expected to fall soon

According to the Labour Force Survey, unemployment was 4.8 per cent in the 4th quarter of 2020. Industries that have been directly affected by the infection control measures have experienced the greatest decline in employment, such as the hospitality industry and culture, entertainment and other services. Although unemployment is unlikely to fall sharply in the coming months, we expect the situation in the labour market to improve when economic activity picks up after this summer. Most of those who were laid off will be able to return to their previous jobs, something that was not so common after previous major economic downturns. According to our calculations, unemployment will be 4.5 per cent in 2021, and then fall gradually to just under 4 per cent in 2024. In comparison, unemployment has averaged 3.7 per cent since the start of the century. The labour force participation rate is expected to increase from the current level of around 66.5 per cent to just over 68 per cent in 2024.