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Reports from the Central Bank of Norway No 4/2002 Inflation Report 3 02 October Norges Bank's Inflation Report In accordance with the Government regulation of 29 March 2001, Norges Bank’s implementation of monetary policy shall be oriented towards maintaining low and stable inflation. The inflation target is set at 2½ per cent. The key interest rate is set on the basis of an overall assessment of the inflation outlook, normally two years ahead. The Inflation Report discusses developments in the Norwegian economy and other factors that influence the inflation outlook. In addition, the balance of risks and uncertainty associated with the inflation projections are assessed. The main aspects of the Inflation Report are presented to the members of the Executive Board who discuss the contents of the report before it is published. The analyses in Norges Bank’s Inflation Report, together with the Bank’s current assessment of the outlook for price and cost inflation and developments in the money market and foreign exchange market, provide a basis for decisions concerning monetary policy instruments. The Inflation Report is published three times a year, and together with Financial Stability, is part of Norges Bank’s series of reports. The report is also available on Norges Bank’s website: http://www.norges-bank.no. The series of reports is included in the subscription for Economic Bulletin. To subscribe please write to: Norges Bank Subscription Service PO Box 1179 Sentrum N-0107 Oslo Norway Telephone: +47 22 31 63 83 Fax: + 47 22 41 31 05 E-mail: [email protected] Editor: Svein Gjedrem Design: Grid Strategisk Design AS Setting and printing: Reclamo grafisk senter AS The text is set in 11½ point Times ISSN 0807-8521 Inflation Report 3/2002 Inflation Report 3/2002 Editorial ..................................................... 5 1. Recent developments.................................... 6 2. International developments..........................11 3. Domestic developments ............................... 15 4. Inflation projections.................................... 21 4.1 The inflation outlook ............................ 21 4.2 Domestic inflationary impulses............. 22 3 4.3 International inflationary impulses ....... 23 4.4 Alternative assumptions and risks to the inflation outlook ............................ 24 Box: −The Scandinavian model of inflation-revisited ....................................... 28 Annex I: Norges Bank`s regional network ........ 31 Annex II: Tables ................................................ 34 The cut-off date for the Inflation Report was 24 October 2002 Inflation Report 3/2002 4 Inflation Report 3/2002 A divergent cycle Developments in the global economy have been weak over the summer and autumn. Both in the US and Europe economic growth has stagnated following strong growth at the beginning of the year. Share prices exhibited a sharp fall through the summer. Oil prices have been high, however. In Norway, this is generat- ing solid income for the petroleum industry and for the state. Norwegian households are generally optimistic about the outlook for their financial situation. Households are borrowing heavily and house prices are high. Private consumption appears to be growing at a fast pace. Annual real wage growth is the highest for close to a generation. Since 1998, nominal wage growth has shown an annual rise that is 2 percentage points higher in Norway than among our trading partners. The Norwegian business cycle and the corresponding wage cycle are divergent from international developments. As a result, the 5 interest rate differential between Norway and other countries has widened and the krone has appreciated markedly. This autumn, investors may also have taken krone positions to hedge against the effects of a possible war in Iraq on oil prices and growth. The relatively high rise in costs in Norway, a strong krone and slug- gish developments in international markets are exerting pressure on many Norwegian companies exposed to competition at home and abroad. The prospects for these companies have therefore dete- riorated considerably compared with companies that supply goods and services to households. Taking into account the effects of a higher interest rate, develop- ments in the Norwegian economy through the summer have been approximately in line with the projections in the July Inflation Report. The appreciation of the krone will probably result in a fall in inflation next year. When the effects of the strong krone gradu- ally unwind, inflation will move up. Consumer price inflation is now projected at 2½ per cent at the end of 2004. The risks to the projection are considered to be balanced. A time horizon of two years when setting interest rates allows monetary policy to contribute to stabilising production. The choice of this horizon prevents monetary policy from contributing to unnecessary volatility in the economy. As an alternative, we could have sought to achieve the inflation target of 2½ per cent using a time horizon of six months to one year. We would then have had to reduce the interest rate sharply this summer. This would have amplified pressures in the Norwegian economy that are so clearly reflected in wage developments and household credit demand. In all likelihood, this would have required marked interest rate increases one to one and a half years ahead. Strict inflation targeting of this type would thus have resulted in more pronounced fluctuations in the interest rate and in aggregate demand and production. Svein Gjedrem 28 October 2002 Inflation Report 3/2002 1 Recent developments The outlook for global economic developments deteriorated over the summer and autumn. Equity prices fell sharply up to Chart 1.1 Import-weighted exchange rate (I-44), trade-weighted exchange rate1) and interest rate the beginning of October but have recently edged up again. differential against other countries2).. Weekly figures Medium and long-term interest rates have also fallen. At the same time, oil prices have risen. The krone has appreciated 4.0 85 further since the July Inflation Report (see Chart 1.1). The 3.5 I-44 (right-hand scale) 90 12-month interest trade-weighted index is now 2¾% stronger and the import- 3.0 rate differential 95 weighted krone exchange rate is 4% stronger than assumed (left-hand scale) in the July report. 2.5 100 2.0 105 Norges Bank raised the sight deposit rate by 0.5 percentage 1.5 TWI (right-hand scale) 110 point to 7% in July. Growth in household borrowing has been 1.0 115 high and house prices have risen. Households are expecting 2000 2001 2002 strong income growth in the period ahead. The outcome of 1) A falling curve denotes an appreciation of the krone this year’s wage settlement points to nominal annual wage 2) The US, the euro area, the UK and Sweden 6 growth of 5½% to 6%. It appears that real wage growth will Source: Norges Bank reach its highest level in more than 25 years. Since 1998, annual wage growth has on average been around 2 percent- age points higher than among our trading partners. Chart 1.2 Consumer prices adjusted for tax changes and excluding energy products (CPI-ATE). Total1) Strong krone restrains consumer price inflation and distributed by imported and domestically produced goods and services2). 12-month rise. Per cent The value of the krone exhibited a sharp rise through the 5 5 first half of 2002. After fluctuating in both directions in July Goods and services produced in Norway and August, the krone has strengthened further this autumn. 4 4 3 3 The movements in the krone exchange rate reflect develop- 2 CPI-ATE 2 ments in Norwegian interest rates and international factors. 1 1 Interest rates have been cut internationally. In spite of grow- 0 0 ing expectations in the market of a reduction in interest rates -1 -1 in Norway, the expected interest rate differential between -2 Imported consumer goods -2 Norway and other countries has remained wide. The sharp -3 -3 1999 2000 2001 2002 fall in the stock market has also induced many investors 1) Norges Bank's estimates up to July 2000, thereafter figures published by Statistics Norway to shift out of international equities into positions with 2) Norges Bank's estimates lower risk. In addition, the fear of war in Iraq has probably Sources: Statistics Norway and Norges Bank prompted some investors to hedge against a sharp rise in oil prices and a global downturn. These factors have probably at times increased investor interest in the krone. Future devel- opments in the krone exchange rate are discussed further in Chart 1.3 Consumer prices. Total and adjusted for tax changes and excluding energy products. 12- section 4.4. month rise. Per cent A stronger krone has contributed to falling prices for 4 4 imported consumer goods. This has pushed down consumer CPI-AT1) price inflation in Norway over the last two months in spite 3 3 of high growth in Norwegian labour costs. The rise in the 2 2 consume price index adjusted for tax changes and exclud- CPI-ATE1) ing energy products (CPI-ATE) has therefore slowed (see 1 1 CPI Chart 1.2). In September, the year-on-year rate of increase was 2.2% after having reached 2.7% in June and July. The 0 0 1999 2000 2001 2002 rate of increase in the total CPI has also been pushed down CPI-AT: CPI adjusted for tax changes by reductions in excise duties and lower energy prices. In CPI-ATE: CPI adjusted for tax changes and excluding energy products 1) Norges Bank's estimates up to July 2000, thereafter figures published September, the year-on-year increase in the CPI was 1.4% by Statistics Norway (see Chart 1.3). Sources: Statistics Norway and Norges Bank Inflation Report 3/2002 During the summer inflation was somewhat higher than Chart 1.4 Consumer prices for some imported goods expected but has since slowed to the path projected in the adjusted for tax changes.
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