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Global Economic Outlook
Norway: Q1 2010 Outlook
By Mikko Forss
- Norway’s oil sector has provided broad support for the economy.
- Emphasis switching from public to private consumption as primary growth driver
- The Norwegian central bank hiked rates twice in late 2009; more hikes can be expected in 2010.
Norway’s economy contracted less than those of its Nordic neighbors in 2009. The country’s large petroleum sector has cushioned the downturn, allowing for a highly expansive fiscal policy. Continued investment in the petroleum industry has supported the mainland economy (excluding oil, gas and shipping), which grew by 0.5% q/q in Q3, the second straight quarter of growth. Norway’s two rate hikes in late 2009 highlight the country’s exceptional economic situation at a time when most central banks are still waiting to begin the tightening cycle. Going forward, higher interest rates, lower public spending and lower investment, together with weakening competitiveness, will weigh on growth. However, 2010 still looks to be a relatively strong year for Norway, owing primarily to private consumption. RGE forecasts the economy will grow 1.8%, one percentage point less than the average annual growth rate in the decade to 2007.
Domestic Demand Driving Growth
High nominal wage increases, low inflation, public cash transfers and rising asset prices have supported private consumption, which grew by more than 1% q/q in both Q2 and Q3 2009. More than 90% of mortgages in Norway have variable interest rates. Thus, record-low interest rates resulted in lower mortgage payments and increased households’ disposable income. Private consumption accounts for more that 50% of mainland GDP and will remain an important growth driver in 2010. While interest rates are set to increase in 2010, they will remain at lower levels than earlier this decade and should not significantly crimp consumption. Rising unemployment will reduce real incomes, but Norway’s unemployment rate of 3.2% in October was the lowest in Europe and should remain comparatively low. As Norway’s high savings rate, currently of 8%, is likely to decrease due to improving consumer confidence, and as inflation is expected to remain under control, private consumption should remain relatively strong in 2010.
Uncertain Outlook for Manufacturers
Norway’s manufacturing production contracted less in the downturn than in many comparable economies, which could explain why Norwegian PMI is low by international comparison. For instance, in December Sweden’s PMI was 58.2, whereas Norway’s—at 50.4—reached the level above 50 that indicates growth for the first time since mid-2008. Continued investment in the oil industry helped Norwegian manufacturers weather the recession, but Statistics Norway expects a decrease in 2010. Rising house prices could prompt an increase in housing investment. Nevertheless, given the bleak mainland manufacturing outlook, investment looks set to contribute negatively to GDP growth in 2010. One of the main challenges for manufacturers—especially for those exporting investment goods—is eroding competitiveness due to a stronger Norwegian krone (NOK), which appreciated more than 15% against the euro in 2009. According to NHO, Norway’s largest industry group, hourly pay rates were almost 50% higher in Norway in autumn 2009 compared to competitors. However, in Q3 2009, strong growth in non-oil exports suggests that worries about the strong currency eroding competitiveness may be exaggerated. Nevertheless, Norway’s main trading partners, such as Germany, will likely experience weak growth, which will limit the growth potential for Norwegian exports in 2010.
Fiscal and Monetary Policy to Gradually Tighten
Expansionary fiscal policy in Norway has helped offset the contraction in other GDP components. The European Commission estimates public consumption and investment increased by 5.2% and 12%, respectively, in 2009. Government expenditure’s contribution to growth will moderate in 2010, as the government attempts to return to its spending rule, which it breached in 2009 to boost the economy. The spending rule stipulates that the government can channel only the expected long-run return of its massive oil fund, estimated to be 4%, to the budget.
Norges Bank (the central bank) cut the key policy rate from 5.75% in September 2008 to 1.25% in June 2009. In October, it became the first central bank in Europe to tighten monetary policy since the onset of the crisis. Another hike followed in December, as Norges Bank unexpectedly raised the key policy rate to 1.75%. Private consumption is strong and house prices have risen significantly, suggesting tighter monetary policy in 2010. Yet the bank is wary about tightening too quickly, as wide interest rate differentials between Norway and the rest of the world could further strengthen the Norwegian krone (NOK) and erode competitiveness. The weak investment outlook also suggests aggressive rate hikes are unlikely. Meanwhile, currency appreciation and slowing wage growth are likely to keep inflation at bay. RGE sees the key policy rate at 2.75% at the end of 2010, in line with the central bank’s forecast rate path.
Increased risk appetite, rising oil prices and widening yield spreads vis-à-vis the rest of the world are the main factors driving the Norwegian krone. RGE expects fewer and smaller rate hikes than many analysts, and we do not expect the NOK to strengthen beyond 8.0 against the euro.