Nov. 6 (Bloomberg) -- Norway’s biggest industry group warned the krone’s 7.2 percent advance against the euro since July is eroding profits at manufacturers like Norsk Hydro ASA, Europe’s second-largest aluminum producer, and says further gains will create “big problems” for the export-reliant economy.

“Norwegian industries may have the worst time ahead of them,” Dag Aarnes, senior economist at the Confederation of Norwegian Business and Industry, said in a telephone interview on Nov. 3. “Large parts of the manufacturing sector are sailing into very big problems at the moment.” The group represents about 19,800 companies employing around 500,000 people.

The world’s sixth-biggest oil exporter suffered a milder recession than most industrialized economies thanks to its petroleum industry, allowing the central bank last week to become the first in Europe to reverse an easing cycle. At the same time, Norges Bank Deputy Governor Jan F. Qvigstad has said the bank must pace rate increases to spur a recovery in domestic demand without boosting the krone and hurting exporters.

Qvigstad said in a Nov. 4 interview it’s “most probable” the bank will raise its key rate, now 1.5 percent, no higher than 1.75 percent by the end of March, compared with a target range as high as 2.25 percent in the same period.

“A marked increase in the interest rate and a wider interest rate differential between Norway and other countries may entail a risk of a stronger-than-projected krone,” Qvigstad said in a speech in Fredrikstad. “This would indicate that the interest rate should not be raised too rapidly.”

‘Middle of Storm’

The currency of the world’s second-biggest natural gas exporter has been the best performer against the euro of the 16 major currencies tracked by Bloomberg since the end of June.

That’s hurt companies such as Oslo-based Norsk Hydro, which supplies the automotive and building industries. For every krone the Norwegian currency strengthens against the dollar, based on an exchange rate of 5.5 kroner, Norsk Hydro’s earnings before interest and tax would be cut by 1.6 billion kroner ($282 million), according to its third-quarter presentation.

The krone has strengthened from 6.4311 against the dollar on June 30, compared with as low as 5.6555 yesterday.

“A weak dollar and a strong Norwegian krone is not a positive situation for us and of course we are concerned if this will continue,” Erik Brynhildsbakken, a spokesman for Hydro, said in a Nov. 4 interview. “For globally exposed industries such as aluminum, we are still in the middle of the storm. The financial crisis for us is not over.”

‘Problem’ Krone

Norske Skogindustrier ASA, the biggest Norwegian newsprint maker, said yesterday that the strong krone hurt earnings last quarter. Dag Opedal, chief executive officer at Orkla ASA, a consumer goods and industrial products firm, told Dagens Naeringsliv last week a “strong krone” and a “high cost level” will hurt industry in coming years.

The krone “is a problem for Norske Skog and all export- related companies from Norway that have production in Norway,” said Hans-Erik Jacobsen, an analyst at First Securities ASA in Oslo.

Industry Minister Trond Giske in a Nov. 2 interview warned the government must contain budget spending to avoid fueling higher interest rates that would strengthen the krone and hurt exporters.

Norway’s central bank isn’t the only regulator facing divergent needs pulling policy in opposite directions. In Sweden, Governor Stefan Ingves is trying to tailor policy to combat half a year of deflation without fueling what Riksbank board members have warned may develop into a housing bubble.

‘Hurting’

Norges Bank Governor Svein Gjedrem is also signaling a possible scaling back of the pace of increases, and has said the strong krone can be a “headache.”

“The krone is hurting. Absolutely,” Aarnes said. “Many Norwegian businesses are telling us they are almost pulling out of certain markets” after becoming unprofitable. The U.K. and Sweden, two of Norway’s most important trading partners, are “extremely difficult.”

While the government expects the non-oil economy to grow 2.1 percent next year, exports, which make up almost half of output, will grow 0.1 percent.

“There is a two-tier economy,” Aarnes said. “The sector competing on the export markets are doing quite badly, while some of the more sheltered industries and the public sector are growing strongly.”

Norway’s manufacturing industry contracted for a third month in October as orders and production slumped compared with the previous month, Fokus Bank, which compiles the purchasing managers’ index, said on Nov. 3. This compares with a fifth month of growth for manufacturing in neighboring Sweden.

Election Pledges

“The development is in stark contrast to similar international indices,” Camilla Viland, an analyst at DnB NOR ASA, Norway’s biggest lender, said in a note.

Manufacturing production dropped an annual 4.4 percent in September, following a 7.8 percent slump the previous month and extending the industry’s decline for a 10th consecutive month, the statistics office said today.

Prime Minister Jens Stoltenberg’s coalition government has pledged to increase spending next year after already using a record amount of the country’s $450 billion oil wealth on stimulus measures this year. Economists say an expansionary budget may lead to a tighter monetary policy which could trigger a strengthening in the currency.

“If they keep on increasing interest rates that would lead to an upward push on the Norwegian krone, which is a big concern,” Aarnes said.

Policy makers meet on Dec. 16 to decide on borrowing costs.

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

Last Updated: November 6, 2009 04:35 EST