FINANCIAL MARKETS AND NORGES BANK'S OPERATIONS(1).

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1 SUMMARY

A number of central banks have raised their key rates since the September Economic Bulletin. The European Central Bank, Bank of England, Danmarks Nationalbank and Sveriges Riksbank increased their repo rates, and the Federal Reserve increased its fed funds rate.

Three-month money market rates have risen in the US, Japan and the euro area. In the US, yields on ten-year government bonds rose, whereas yields fell in Japan. The Norwegian krone weakened against both the yen and the US dollar. The depreciation was strongest against the yen, at about 10%, whereas the krone weakened by just over 3% against the dollar.

The Norwegian krone has strengthened against the euro by 1.3% since the September Economic Bulletin. The krone exchange rate against the euro fluctuated between NOK 8.11 and NOK 8.37 in this period. The trade-weighted index has weakened by just over 0.3%.

Norges Bank has lowered its deposit and lending rates by 0.5 percentage point in this period. This decision was based on projections of slower growth in the Norwegian economy. However, most money market rates have remained unchanged. Short money market rates declined before key rotes were lowered, but the liquidity premium around the mm of the year contributed to a renewed rise in short rates. The money market indicator has moved down by 0.4 percentage point to 6.0% and the three-month interest rate differential against the euro was 2.6 percentage points on 8 December, which is 0.7 percentage point lower than in the September report.

The yield curve in the bond market has flattened out since the previous report. Yields have risen slightly on the two government bonds with the shortest maturities, whereas yields have remained unchanged for the three with the longest maturities.

Bank interest rates were reduced from the second to the third quarter of 1999. Lending rates declined slightly more than deposit rates, narrowing the interest rate margin. Lending rates were also reduced in state lending institutions, life insurance companies and mortgage companies.

Year-on-year growth in the money supply was 9.9 % at end-October. The indicator for twelve-month growth in private and municipal sector gross domestic debt (C2) was 8.0%. Growth in C2 moved up by one percentage point in September, reaching approximately the same level prevailing at end-October. The indicator for twelve-month growth in total credit (C3) was 9.8% at the end of the third quarter, compared with 10.1% at the end of the second quarter of 1999.

2 FOREIGN EXCHANGE AND HONEY MARKETS AND NORGES BANK'S OPERATIONS

2.1 Foreign exchange market

The Norwegian krone has appreciated by 1.3% against the euro since the last report. The krone exchange rate against the euro fluctuated between NOK 8.11 (3 December) and NOK 8.37 (18 October). The trade-weighted index has weakened by 0.3 %.

Table 2.1 shows movements in banks' total foreign currency transactions in 1998 and so far in 1999. Norges Bank has purchased foreign currency from banks equivalent to NOK 9.0bn up to 26 November this year. These purchases must be seen in connection with the accumulation of capital in the Government Petroleum Fund. Norwegian banks have made spot currency sales to the foreign sector equivalent to NOK 9.3bn and forward currency purchases from the foreign sector equivalent to NOK 5.7bn. The foreign sector has reduced its krone claims on banks by NOK 10.5bn while purchasing VPS-registered bonds (bonds registered with the Norwegian Central Securities Depository) for NOK 12.5bn during this period.

Table 2.1 Transactions relating to Norges Bank's exchange market transactions.(1) In billions of NOK

1998(2) 1999(3) A. Norges Bank's net sales of currency to banks 11 -9.0 1. Spot 11 -9.0 2. Forward 0 0.0 Used by banks to provide cover (offsets): B. Foreign(4) 10 3.6 1. Spot -15 9.3 2. Forward 25 -5.7 C. Norwegian sectors, non-bank(5) -13 -24.2 1. Spot 20 -15.9 2. Forward -15 -9.0 3. Increase -18 -0.7 D. Other 14 11.6 Memorandum item: Norges Bank's international reserves 142 144.7 (1) For further details, see Table 48 in the statistical annex.

(2) Based on figures from the Bank% statistics.

(3) Weeks 1-47.

(4) positive figures denote foreign exchange sales from banks. Negative figures denote purchases.

(5) End October

Source: Norges Bank

Banks' spot currency purchases from Norwegian customers came to NOK 15.9bn and forward currency purchases to NOK 9.0bn. However, the banks reduced their net currency claims on Norwegian customers by NOK 0.7bn.

2.2 The money market and Norges Bank's operations

Interest rates

Norges Bank lowered its key rates by 0.5 percentage point on 23 September, reducing the deposit and lending rates to 5.5% and 7.5% respectively. The decision to lower these rates was based on projections of slower growth in the Norwegian economy. However, most money market rates have not changed since the September Economic Bulletin. Short money market rates declined before key rates were changed, reflecting market expectations of lower interest rates. The liquidity premium around the turn of the year led to a rise in short money market rates. The money market yield curve shows that there was also a substantial liquidity premium around the turn of the year. When the three-month swap rate's maturity was set for 3 January on 29 September, it rose by 34 basis points from 5.8% to 6.2%. The rate rose a further 27 basis points during October before receding in the last half of the month. At end-November, the three-month swap rate was 5.9%. After third-quarter GDP growth proved to be sharper than expected, short rates once again moved on an upward trend, reaching 6.0% on 8 December. The fall in the liquidity premium after the new year shows that fears of liquidity problems in connection with the turn of the year have eased considerably over the last month.

The money market indicator (an average of yields for maturities of one week to three months) has fallen from 6.4% to 6.0%. The interest rate differential against the euro (effective three-month) has also declined, from 3.3 percentage points to 2.6 percentage points on 8 December.

Money market liquidity

Norges Bank influences money market rates by using its key rates to set a corridor for interest rates, ie banks' interest rates on sight deposits in Norges Bank (deposit rate) and the interest rate on overnight loans to banks (overnight lending rate). Norges Bank can influence interest rates in the money market within this interval through the supply and withdrawal of krone liquidity. Norges Bank counters seasonal variations in banks' liquidity associated with government incoming and outgoing payments through the Bank's liquidity policy instruments. Norges Bank introduced a collateral requirement for fixed-rate loans (F-loans) on 1 September 1999, and has not made use of repurchase agreements in its management of liquidity since that time, ie collateralised F-loans and fixed-rate deposits (F-deposits) are the only liquidity...

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