Oct. 27 (Bloomberg) -- Norges Bank will probably raise its benchmark interest rate tomorrow, becoming the first European central bank to reverse monetary support measures as policy makers steer the oil-rich economy through its recovery.

The Oslo-based bank will lift the overnight deposit rate by a quarter point to 1.5 percent, the first increase in more than a year, according to 19 out of 20 economists surveyed by Bloomberg. The other forecast an increase to 1.75 percent. The bank will announce its decision at 2 p.m.

The world’s fifth-largest oil exporter came out of recession in the second quarter after investment in its petroleum industry, a stimulus package equivalent to 4.7 percent of gross domestic product and record-low borrowing costs fueled domestic demand. Prime Minister Jens Stoltenberg, whose coalition government was re-elected last month, has pledged to raise next year’s spending in excess of national fiscal guidelines even after recovery took hold.

“They are going to raise this month and I think they will raise interest rates to about 4 percent by the end of next year,” said Sunil Kapadia, an economist at UBS AG in London.

The only Scandinavian country outside the European Union needs higher borrowing costs to offset the effect of government stimulus. The registered unemployment rate dropped to 2.7 percent in September, Europe’s lowest, and annual retail sales have grown for three consecutive months. House prices, not taking inflation into account, have returned to their pre- crisis peak from the summer of 2007, the Finance Ministry estimates.

Inflation Target

Inflation has hovered close to the bank’s 2.5 percent target and was 2.4 percent last month, adjusting for the effect of taxes and energy. This year, the rate has exceeded the central bank’s target in six out of nine months.

“Better consumer confidence and strong government stimulus are contributing to a quicker recovery than expected,” Bjoern- Roger Wilhelmsen, senior economist at First Securities ASA in Oslo, said in a note to clients.

The krone was little changed at 8.3750 per euro at 9:36 a.m. in Oslo. The krone has gained 7.9 percent since the end of June, making it the second-best performer of the 16 major currencies tracked by Bloomberg in the period after the New Zealand dollar.

Gains in the krone will limit the scope of rate increases, according to DnB NOR ASA, as policy makers try to balance the needs of the domestic economy against the task of supporting the country’s exporters.

Struggling Exporters

“The export sector is still struggling and a stronger krone will only weaken the sector further,” said Maren Romstad, a currency strategist at DnB NOR ASA, Norway’s biggest bank. This “will limit the room for the central bank to hike.”

Erik Bruce, Oslo-based senior economist at the biggest Nordic lender, Nordea Bank AB, expects the central bank to move “gradually,” and increase rates at every second meeting to 2.75 percent within 12 months. “They will move much more cautiously.” If the bank “moves too fast, we will surely see an even stronger krone and that will lead to a too tight monetary situation, too low inflation.”

Former Finance Minister Kristin Halvorsen on June 22 warned mortgage holders against basing home purchases on an assumption that interest rates will remain at the current record low. Central bank Governor Svein Gjedrem said on Sept. 30 that asset prices “have risen sharply and probably excessively,” characterizing policy rates as “extremely low.”

Oil Wealth

“They will start raising rates and try and encourage people to be a bit more cautious in their borrowing,” Kapadia said. “I think it is the right thing to do.”

The country’s oil wealth has shielded it from the worst of the economic crisis, and mainland gross domestic product, which excludes oil, gas and shipping, grew 0.3 percent in the second quarter, ending six months of recession. The government expects the economy to grow 2.1 percent next year after contracting 1.1 percent this year. The jobless rate will average 3.2 percent this year and 3.7 percent in 2010.

After spending a record amount of its oil wealth this year to jolt the economy out of a trade-led recession, the government on Oct. 14 announced plans to spend even more in 2010. It will transfer 148.5 billion kroner from its $450 billion oil fund to cover the so-called structural non-oil budget deficit.

Norway, which is also the world’s second-largest natural gas exporter, puts most of its revenue from oil and gas in a pension fund that invests abroad to avoid stoking inflation in the domestic economy. The Government Pension Fund - Global is Europe’s largest equity investor.

Overspending

Expenditure guidelines stipulate the government should limit spending to the expected return of the fund, which is estimated at 4 percent. In 2010 the government will exceed the spending limit by 44.6 billion kroner, overspending for a second consecutive year.

A Norges Bank rate increase would make it the third central bank to raise rates since the global credit crisis started to ease after the Bank of Israel lifted its lending rate a quarter point in August and Australia’s Reserve Bank raised its overnight cash target rate by 0.25 point earlier this month. The bank will also publish a new set of forecasts for the economy and interest rates.

To contact the reporter on this story: Josiane Kremer in Oslo at Jkremer4@bloomberg.net.

Last Updated: October 27, 2009 05:08 EDT