Oil Risk Blows Up Inflation Goal as Norway Targets Krone

  • Norges Bank signals rate cuts as inflation above 2.5% target
  • Ignoring mandate makes bank unpredictable, Commerzbank says

Has Norwegian central bank Governor Oeystein Olsen thrown away his inflation target?

That’s what analysts were wondering Thursday after he unexpectedly cut interest rates to a record low and signaled further easing, even as he predicted faster inflation.

Norges Bank is “saying that they are no longer gearing monetary policy toward their inflation target, but rather on economic growth,” said Esther Reichelt, a currency strategist at Commerzbank AG in Frankfurt. “They are hoping inflation expectations will not cause too much bubble creation.”

Olsen is following his colleagues in Stockholm and Frankfurt into uncharted monetary policy, but for very different reasons. While they are unleashing record stimulus to revive inflation, policy makers in Norway are stepping in to rescue western Europe’s biggest oil producer from the crude price slump.

The governor is sanguine that inflation will remain near target and eventually slow as the effects of a weakening krone fade. Inflation has in part jumped amid rising import costs as the krone has slumped about 16 percent over the past year. Still, the bank now estimates that underlying inflation will remain above target until early 2017, while earlier seeing inflation below target through 2018.

Those krone effects got even stronger on Thursday as the currency fell as more than 2 percent against the dollar and the euro, fueling further inflation risks.

“We are not very worried about the inflation prospects looking forward,” Olsen said Thursday in an interview after a press conference in Oslo. 

The governor emphasized the bank has a flexible inflation target and needs to take into account output and employment as he battles a slowdown that risks stalling Scandinavia’s richest economy.

A 50 percent drop in Brent crude in a year is threatening to halt growth in an economy that relies on petroleum for almost a quarter of its output. Norges Bank has cut rates three times since the drop in oil prices quickened, and is now signaling a more than 50 percent chance of another cut in the coming year. The bank also sees a deeper drop in oil investments next year, which will exacerbate a slowdown in growth.

The government has flagged it will use more of Norway’s $880 billion wealth fund in its budget, due to be released Oct. 7. Oil companies have announced more than 25,000 job cuts, according to DNB Markets, helping drive unemployment to its highest level since 2006.

That should have a cooling effect on wage growth, and in turn, inflation. The bank predicted on Thursday that wages will rise 2.75 percent this year and the next.

The bank now sees Brent crude creeping up to about $56 a barrel by the end of 2016, $14 lower than its projection in June. That assumption pushed down its forecasts for mainland GDP growth next year by a quarter of a percentage point to 1.25 percent. Petroleum investments will plunge 12.5 percent this year and 10 percent next year. It had earlier predicted a 5 percent decline for those investments for 2016.

“We clearly know now that the real economy is more important than inflation,” said Marius Gonsholt Hov, an economist at Svenska Handelsbanken AB in Oslo.

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