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Right in line with expectations, the Norwegian central bank has raised the key interest rate significantly. It rose by 0.5 percentage points to 1.75 percent. This is the fifth interest rate hike since the start of the pandemic and the second significant move in a row. During the pandemic, the key interest rate was cut to zero in May 2020. We expect another rate hike in September in order to combat inflation.
The labor market in Norway is booming. And it is no longer just temporary factors such as energy and commodity prices that are driving inflation. Other "permanent inflation drivers" such as wage increases, and rents are also rising sharply. The central banks are therefore reacting to this. Electricity, food and other everyday goods have become more expensive, and this is reducing consumer spending capacity. The rise in prices is a sign that supply and demand are out of balance. When the labor market is as strong as it is now, this has the potential to contribute to a spiral of price and wage growth. Interest rate hikes are likely to take effect more quickly in Norway than in the U.S.A., as both households and companies in Norway have a greater volume of loans with variable interest rates.
Long-term interest rates lower than short-term ones
So far, since the introduction of stable inflation targets in the mid-1990s, Western central banks have managed to avoid the large inflation swings that were prevalent in the 1970s and 1980s. From our perspective, there is a clear view in central banking circles that it is much more costly in the long run to lose confidence. Thus, central banks aim for keeping inflation low and stable and accept a period of weaker growth in the short run, perhaps even a recession.
A common feature between Norway and the U.S.A. is that market participants assume that the interest rate peak will be reached next winter and that the key interest rate will then drop to some extent This is reflected, among other things, in the fact that long-term interest rates are now lower than short-term interest rates. The spread between ten-year rates and two-year rates has been rising. On August 17, 2022, the two-year yield in the United States was 3.3 percent and the ten-year yield was 2.85 percent. The Norwegian trend is not much different.
The Fed publishes a "dot plot" depicting what committee members think the future policy rate will be. It peaks at a median of 3.75 percent in 2023 before falling beginning in 2024. The market in the U.S. is expecting a faster rate cut than indicated by the central bank. In June, Norges Bank published its previous analysis, which suggested the policy rate would be just above 3 percent in 2023.
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