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Norwegian economic outlook: Normalisation

Norwegian economic outlook: Normalisation

The Norwegian economy has now regained all the ground lost during the coronavirus crisis. The situation is still uncertain, but with one of the highest vaccination rates in the world, chances are good that Norway will avoid new measures which could weaken the economy. Unemployment has dropped sharply, in sync with the reopening of society, and will continue to do so. At the same time, the number of job vacancies is record high, and signs of mismatch in the labour market are emerging – which could lead to higher wage growth. Norges Bank will start normalising interest rates in September. The housing market rally is over and prices will likely flatten going forward. The NOK will remain weaker than previously expected.

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Economic Outlook September 2021 cover image showing a butterflyWe have long said that if we solve the health crisis, then we will also solve the economic crisis. This summer was the definitive turning point for the pandemic and thus also for the economy, as outlined in the two previous issues of Economic Outlook. The Norwegian economy has recovered swiftly after restrictions were gradually lifted.

Activity in the Norwegian economy surged during the summer. As restrictions were gradually rolled back, spending and demand rose sharply. A desire to resume normal spending patterns, plenty of money left over after the crisis and “staycation” have all led to a significant increase in services consumption. Moreover, retailers have benefitted from the reopening of physical shops. Activity in the mainland economy rose 1.4% in Q2 and was thus back at pre-pandemic levels already in June. In tandem with the recovery, unemployment fell to 3% in July after hovering around 4% in Q1 2021 and surpassing 10% at the worst point last spring.

One of the top vaccination rates globally

Economic developments in the coming period will probably continue to be affected by the virus. The vaccines currently used may turn out to be less effective against new variants. If higher infection rates lead to a sharp increase of hospital admissions, new restrictions will likely be imposed – which will adversely impact the economy.

However, Norway is in a good position with the vast majority of adults wanting to be vaccinated and by having one of the world’s highest vaccination rates. More than 90% of the adult population has received at least one dose and most adults will soon be fully vaccinated. Moreover, vaccination of 16-17-year-olds will soon start. Given the high vaccination  rate, there are good chances that Norway will avoid new, nationwide restrictions. The risk of an economic setback in Norway is therefore lower than in many other countries where the population is not as eager to get vaccinated. In addition, the mRNA vaccines used in Norway are effective against the more infectious Delta variant. While the effectiveness against symptomatic infection is lower than for other virus variants, the vaccines still offer very good protection against serious illness and death. Experience from Israel, one of the first countries to vaccinate large parts of its population, shows that a third booster dose may be necessary to maintain a high degree of protection particularly among the most vulnerable population groups. Several countries have started giving booster shots, and Norway will likely follow suit.

Given the worries over the spread of the Delta variant and other possible new mutations, we will probably have to live with certain restrictions for longer. Particularly travel restrictions into Norway. The travel industry and the cultural sectors that depend on tourism are therefore unlikely to make a full return to normality until a larger share of the global population is fully vaccinated. This could take a long time. But otherwise Norwegians will probably be able to return to an almost normal life.

Norway: Macroeconomic indicators

2019 2020 2021E 2022E 2023E
Real GDP (mainland), % y/y 2.3 -2.5 3.9 3.9 1.3
Household consumption 1.4 -6.9 5.0 8.0 3.5
Core consumer prices, % y/y 2.2 3.0 1.6 1.8 2.0
Annual wage growth 3.5 3.1 3.0 3.2 3.4
Unemployment rate (registered), % 3.7 4.6 3.6 2.4 2.3
Monetary policy rate, deposit (end of period) 1.50 0.00 0.50 1.50 1.75
EUR/NOK (end of period) 9.87 10.47 10.30 9.90 9.80

Growing mismatch problems in the labour market could result in wage pressure at a higher unemployment level than we have been used to.

Dane Cekov, Analyst, Norway

Graph: A / GDP back at February level during the summer B / Unemployment will decline further

Further upturn in sight 

We expect economic activity to rise further and unemployment to continue to fall once the last remaining restrictions in Norway are lifted. Signals from the authorities indicate that the last step of the reopening plan will be implemented in September when large parts of the adult population are fully vaccinated. The scrapping of the one-metre rule will especially benefit cultural activities. Households still have ample savings put aside that could be used for consumption.

Last year, many businesses put investment plans on hold due to high uncertainty. But now they plan to carry them out. Investment growth in the mainland economy will be boosted by the green transition and ESG investments that will come underway.

Fiscal policy has played a key role during the coronavirus crisis. The aid packages have been crucial in keeping corona-impacted businesses afloat. Once the economy is back to normal, public budget expenditure will fall. This does not mean that the budget will become less expansionary; it is rather a reflection of the recovering economy. In an election year like this year, the deficit may also quickly swell by a few billion.

Labour market mismatch could lead to wage pressure

As the economy continues to recover, unemployment will gradually decline further to a more normal level. After a couple of years of low real wage growth, a stronger labour market will boost the bargaining power of the trade unions. Hence, real wage growth will pick up in the coming years. Many businesses already find it difficult to recruit qualified labour, and there is a record-high number of job vacancies, although unemployment is still higher than before the coronavirus outbreak. Growing mismatch problems in the labour market could result in wage pressure at a higher unemployment level than we have been used to (see also the Norway theme article).

Inflation close to 2%

Headline inflation has this year been driven up by significantly higher electricity and petrol prices than last year. Gradually, the effect on price growth of the high energy prices will fade. But global commodity and input prices have continued to rise sharply due to a combination of production bottlenecks, lack of transportation capacity and increased demand. Companies globally say they plan to increase prices as their input costs have risen but also because the economic recovery allows them to raise their margins. Higher import prices will push consumer prices higher in Norway. This, coupled with higher wage growth, suggests that headline inflation could hover at close to 2% in coming years.

Whereas headline inflation has risen, core inflation has fallen. The reason is lower growth in prices of imported consumer goods, which in turn is due to the fading effect of last spring’s weak NOK and the NOK’s subsequent strengthening. With a relatively stable NOK exchange rate going forward, imported inflation will gradually be driven by price growth in other countries. At the same time, prospects of higher wage growth and rents suggest that core inflation will gradually move higher in the next few years.

Norges Bank ready to gradually normalise interest rates

Norges Bank has long said that it wants to see clear signs of economic conditions normalising before it will gradually normalise interest rates. Those signs became very clear in the spring and summer months. Therefore it came as no surprise when Norges Bank in June communicated that it was ready to gradually hike the policy rate, with the first hike due in September. In line with our forecasts from May, the latest rate path showed a likely policy rate move to 0.50% by end-2021 and further up to 1.25% by end-2022.  We think the policy rate will be hiked further to 1.75% during 2023. The policy rate will then approach what Norges Bank calls a normal level.

The NOK would have to strengthen sharply to ruin Norges Bank's plan.

Kjetil Olsen, Nordea Chief Economist, Norway

Graph: C / Moderately stronger NOK D / Norges Bank will hike rates after the summer

The housing market rally is over

Housing prices rose sharply following Norges Bank’s rate cuts during the spring of last year. Lately, the price trend has moderated somewhat, and in Oslo prices have declined slightly. The rate cut effect has probably faded, and home buyers have become aware that interest rates will rise after the summer.  Viewed in isolation, this points towards lower housing prices. At the same time, wage growth will rise in tandem with the labour market recovery. All in all, this suggest a largely sideways trend in housing prices in the next few years. The demand for new housing remains at a high level. We therefore expect new housing starts and residential investment to continue to increase going forward.

Risk of weaker NOK towards year-end

Norges Bank will be among the first central banks in the western world to start normalising interest rates. Many wonder whether Norges Bank can increase rates while other central banks keep rates unchanged. The only direct link between global interest rate levels and the level in Norway is the NOK exchange rate. So far the NOK performance has been much weaker than forecast by Norges Bank. The NOK would therefore have to strengthen sharply to ruin Norges Bank’s plan.

The NOK has weakened over the summer. Near term, we expect a slightly lower EUR/NOK cross. Viewed in isolation, Norges Bank’s rate hikes would suggest a somewhat stronger NOK. However, the NOK has difficulty performing when the USD strengthens, and we think that a benign trend in the US economy and a more hawkish Fed will lead to USD appreciation. Consequently, we see very little downside in USD/NOK and we lean rather in the direction that the cross could move higher towards year-end. At the same time, we cannot rule out a periodically higher EUR/NOK if sentiment in the financial markets sours. The NOK is not a safe-haven currency.

This article originally appeared in the Nordea Economic Outlook: A new phase, published on 1 September 2021.

Authors:

Kjetil Olsen, Nordea Chief Economist, Noway
Kjetil Olsen, Nordea Chief Economist, Norway

Dane Cekov, Nordea Analyst
Dane Cekov, Nordea Analyst

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