FOURTH QUARTER 1999
The period of strong growth that prevailed during the latter part of the 1990s has now been replaced by a period of slower growth. However, there are still strong pressures in parts of the Norwegian economy. The risk of a pronounced downturn has decreased since the September Inflation Report. The forecast for economic growth is thus higher in this report. Mainland GDP growth is estimated at 1% in 1999 and 3/4% in 2000, and is thereafter expected to return to the long-term trend rate of growth in the economy.
The slowdown in growth is characterised by two divergent trends. Growth in public and private consumption will continue to fuel pressures in the labour market for service industries and the public sector. This will be intensified by the resource shortage in these segments of the labour market. On the other hand, profitability in large parts of the manufacturing sector is being squeezed by high cost levels and low international prices. This will primarily be reflected in a fall in fixed investment. Furthermore, petroleum investment will show a marked contraction after several years of record-high investment in the North Sea. As a result, employment in manufacturing industry is set to decline sharply.
Norges Bank expects consumer price inflation to remain at about the current level next year. Consumer prices are projected to rise by 2 1/4% in both 1999 and 2000. The projection for next year has been revised upwards by 1/4 percentage point, primarily reflecting the Storting's (Norwegian parliament) decision to increase indirect taxes in the budget for 2000. Moderate wage growth is pushing down consumer price inflation. On the other hand, higher international growth is likely to fuel externally generated price impulses. Consumer price inflation is projected to decline to 1 3/4% in 2001.
This Inflation Report discusses the medium-term outlook for the Norwegian economy to 2003. In the years after 2001, higher growth and increased demand for labour may again push up wage and price inflation. All in all, wage growth is expected to edge up when growth in the economy picks up. Given the current projections, price inflation may then show a slight increase.
Section 5 of the report discusses the effects of changes in some of the key assumptions underlying the projections. The projections are based on the technical assumptions that the krone exchange rate will remain stable against European currencies and that money market rates will move in line with market expectations, as reflected in forward rates in December. Forward rates indicate that interest rates are expected to remain approximately unchanged next year. It is assumed that oil prices will gradually decline from today's level to a range of USD 15-17 a barrel.
The projections in this report are based on unchanged wage determination, ie that the contraction in the manufacturing sector has a restraining effect on wage growth in spite of relatively strong pressures in service sectors. Any change in wage formation could result in higher-than-projected wage growth. Wage growth is estimated to be up to 1 1/2 percentage points higher in 2001 if labour market pressures in service industries have a full impact on the wage level.
This year, growth in government budget expenditure has been substantially higher than the level implied by the government budget adopted last autumn. Measured by the cyclically adjusted budget indicator, the total tightening of fiscal policy has been approximately halved compared with the original budget resolution. The estimates are based on a neutral fiscal policy for the years ahead. The assumptions entail approximately unchanged taxes and public spending growth on a par with the trend rate of growth in mainland GDP.
Sharp increases in individual expenditure items, particularly a number of social security items, early retirement schemes and priority areas in the health sector, is likely to put some pressure on fiscal policy. The calculations show that an annual increase in public expenditure equivalent to 1/2% of mainland GDP could, in the absence of other measures, push up price inflation towards 2 1/2% in 2003. If the increase in expenditure is financed through tax increases, the effects of higher expenditure on consumer price inflation may be curbed. This presupposes, however, that changes in taxes are not compensated by higher growth in nominal wages. If, on the other hand, this financing results in a corresponding rise in wage growth, the effects on consumer prices may be stronger than estimated.
Section 5 also looks more closely at the effects of changes in the interest rate on consumer price inflation. The effect will partly depend on changes in the krone exchange rate. The estimates indicate that a 1 percentage point change in the interest rate over a three-year period will result in a change in the annual rise in consumer prices in the order of 1/4-1/2 percentage point.
2 RECENT DEVELOPMENTS
2.1 Price developments
Price inflation somewhat higher than projected
Price inflation has been slightly higher than expected in recent months. In November, the consumer price index rose by 2.8% compared with the same month one year earlier (Chart 2.1), primarily reflecting the rise in electricity prices. Between August and November electricity prices rose by 18%. The underlying rise in prices, excluding changes in indirect taxes and electricity prices, has exhibited a more stable trend. In November, the underlying rise in prices was 2.5%.
[Chart 2.1 OMITTED]
Food prices have shown a far more moderate rise this autumn than one year ago. External trade statistics for the third quarter show that prices for imported food fell by about 10% compared with the same quarter last year, while they rose by 4% the previous year. This may also have influenced the price trend for Norwegian-produced food.
Prices for imported consumer goods have moved on a downward trend since the effects of the Asian crisis were felt in the summer of last year. Service prices, with wages as a dominant cost factor, are still pushing up the year-on-year rise in consumer prices, but the rate of increase is slowing (Chart 2.2).
[Chart 2.2 OMITTED]
Price inflation among our traditional trading partners was 1.3% in October. Measured by the Harmonised Index of Consumer Prices (HICP), the rate of increase in prices in the euro area was 1.4% in the same month. The surge in oil prices has pushed up consumer price inflation among trading partners, although inflation is still moderate (Chart 2.3). Measured by the HICP, price inflation in Norway was 2.6% in November, against 2.4% one month earlier. The planned broadening of the basis for the HICP will probably entail an increase in price inflation in Norway, measured by this index, to the rate of increase in the traditional consumer price index. The broadening will probably not influence the rate of increase in the HICP in the euro area.
[Chart 2.3 OMITTED]
2.2 Interest rates, the exchange rate and monetary conditions
Stronger exchange rate and transitory rise in interest rates
Norges Bank has lowered its key rates by 0.5 percentage point since the September Inflation Report. Since the beginning of the year, key rates have been reduced in five steps by a total of 2.5 percentage points. Internationally, the tendency has been to increase central bank key rates in recent months. In the euro area, the interest rate increase on 4 November was motivated by high monetary growth and an increase in producer prices, which were viewed as increasing the risk of higher price inflation. Moreover, it was emphasised that the economic framework conditions were now more favourable than in April when key rates were reduced.
In the US, a factor cited as part of the explanation for the increase in the federal funds rate was a tight labour market. The central banks in the UK, Sweden, Denmark, Canada, New Zealand and Australia have also raised their key rates since the September Inflation Report.
Three-month money market rates remain virtually unchanged compared with the level prevailing in September. However, three-month rates have been fairly volatile during the period. During the last days of September, nominal three-month rates rose by about 0.3 percentage point to 6.2%, followed by a gradual increase to mid-October before peaking at 6.5%. Thereafter, three-month rates fell again to 6.0% on 10 December. The increase primarily reflected the uncertainty associated with the year 2000, which has increased the cost of borrowing at the end of the year. This situation was not specific to Norway. In the euro area, the US, the UK, Japan and Sweden, interests rates showed a comparable, if not more marked, increase. The fall in interest rates since mid-October suggests, however, that the uncertainty linked to the year 2000 issue has diminished.
FRA rates now indicate that three-month rates are expected to fall slightly at the beginning of 2000, and then edge up through the year.
Ten-year government bond yields are now at 6.0%, or about the same level as in September. Internationally, bond yields have increased markedly through 1999, and Norwegian bond yields have largely followed this trend. Ten-year yields in Norway have continued to move up since the Inflation Report was presented in September. In mid-October, ten-year yields stood at 6.4%, thereafter moving down by about 0.4 percentage point. This also reflects the movement in international yields. The yield differential against comparable German bonds has hovered around 0.9 percentage point in October and November.
The krone has appreciated slightly against the euro since the September report. On 10 December, the exchange rate was NOK 8.11. In the first half of October, the krone depreciated and stood at 8.37 in mid-October. Since then, the krone has appreciated (Chart 2.6). The krone depreciated during the same period that three-month money market rates increased, and...