Norges Bank Review: Excessive Last Mile Caution?
It was always the very high likelihood that the thrust of recent data and the Board’s clear caution would mean that the Norges Bank would leave its policy rate at 4.5% for a fourth successive meeting and this is what duly occurred. Perhaps more notable was that the it was more explicit in stressing ‘policy to stay on hold for some time ahead’ rhetoric, this backed up formally with an updated policy outlook that sees no rate cut until early 2025, some three months later than hitherto. This is in spite of a downgrade to this year’s CPI outlook reflecting a broad undershoot of its inflation expectations. Instead, policy is being shaped by an upgrade to the wage outlook which results in higher CPI projections out to 2027 and where the CPI-ATE measure stays above the 2% target. Even so, the revised policy outlook sees a slightly softer rate at the end of the forecast horizon (Figure 1), the question being whether this is seen being a terminal or even neutral rate. We think continued inflation downside surprises in coming months, as weaker profit margins offset labor costs issues, will deliver at least one cut by end-year and maybe over 100 bp in 2025!
Figure 1: Policy Path Easing Deferred
Source: Norges Bank
Against a backdrop of continued currency weakness, the Norges Bank Board has almost disregarded the size and cause of the recent inflation undershoot, instead preferring to focus on what it says is a perkier real economy, possibly in the hope that this may bolster sentiment in the FX market regarding the currency. Indeed, it has revised the GDP picture markedly for this year but little changes from 2025 onwards, still largely preserving a negative output gap.
As for inflation, we think the Board is underestimating the extent to which it has retreated of late on an underlying basis, this very much evident in seasonally adjusted data, for various core measures; we have computed a core measure in which food is excluded from the familiar CPI_ATE figure. Both this core and the CPI-ATE measures show recent seasonally adjusted m/m dynamics to be running at pace below 0.2% per month, albeit with some noise in the latest (May) numbers, ie consistent with the 2% target, if not an undershoot. And this is in spite of the impact of rental inflation (around 17% of the CPI) running still at over 4% y/y, implying headline inflation ex rents now at 2.5%. This begs the question whether Norges Bank policy is actually buttressing inflation as higher interest rates therefore mean higher inflation as rents are largely being driven by (high) mortgage rates.
Even so, a weaker currency, higher global rate expectations, slightly stronger growth, a recovering housing market and more generous pay settlements than expected are all factors that will be playing on the minds of the ever- cautious Norges Bank, clouding any assessment that even y/y inflation had been slightly lower than officially expected. Indeed, the Board may be swayed by its latest regional survey where the contacts concerned reported that full capacity utilization has increased and contacts also revised up their wage growth estimates for 2024 and 2025 to 5.2% and 4.3%, respectively
We are wary about the apparent recovery in activity, not least given the impact of what has been unseasonable weather patterns and monthly GDP data that have fallen in four of the last five months of data. Regardless, given the Board’s (what we see as excessive) caution, the risks are clearly skewed towards cuts coming later than we had anticipated. Amid an economy with a tight labour market and rapidly rising wages but low productivity growth, the Board may very well worry about inflation persistence, certainly on the costs push side. Notably, the Norges Bank was the first DM central bank to start hiking; it clearly has not wanted to be the first to start easing and it may instead be among the last as it confronts the ‘last mile’ problem!