Norges Bank should cut rates now
The timing is the best in two years
This article originally appeared in DN.
Few believe in an interest rate cut this week, and the market believes in September.
But I think it should happen now: imported inflation will be very low going forward, the krone exchange rate is holding up and the dollar exchange rate is on the decline.
Central Bank Governor Ida Wolden Bache has been hinting at a possible interest rate cut since March last year (see annex), when she surprisingly suggested that September could be a possible month for the first cut. That is starting to feel like a long time ago. Although the postponements are well argued, there is an element of credibility at stake, not only in the forecasts presented, but also in the wording.
Many would argue that when core inflation in May was 0.3 percentage points lower than Norges Bank thought it would be, then there should be a cut in the key rate this week.
In its March inflation forecast, Norges Bank projected a higher level of core inflation through the second half of this year. The Monetary Policy Committee expected this to be as high as 3.5 percent. I argued in advance of the March meeting for a higher inflation path, but today it seems somewhat high, given the lower inflation in both the euro area and Sweden.
I would think that Norges Bank will adjust its inflation projections for the second half of the year somewhat downwards this week. If that happens, it will also strengthen the argument for a rate cut through the autumn, and Norges Bank may go so far as to set this for September.
It has been fifteen months since Norges Bank gave the first indication of a lower key rate. That is a long time ago. Now it should be said that predicting something about the future is not easy. There is a lot that changes along the way and therefore necessarily affects decisions.
Norwegians are a patient people, and most have done well through the long period when interest rates have been high. But I understand that it must be a bit frustrating that the prospect of an interest rate cut has been extended by a year, when core inflation in the same period has fallen from 4.9 percent to 2.8 percent.
The reasons for the postponement have been many. The krone exchange rate, real wage growth, the general level of economic activity, interest rate differentials with other countries are some that are often mentioned, in addition to the fact that inflation is still higher than the target.
But suggesting an interest rate cut for as long as Norges Bank has done, without implementing it, perhaps raises a question of credibility—to the forecasts and other factors the committee emphasizes for interest rate decisions.
I am not saying that it has been wrong to keep the key interest rate unchanged. Quite the opposite. I have argued for the same. But I think that suggesting a cut within a six-month period, as Norges Bank has worded in most of the aforementioned interest rate decisions, has been weakly argued.
To suggest something over such a long period of time without actually implementing it is therefore problematic. Should core inflation in August be higher than today, but lower than the 3.5 percent Norges Bank had in its latest forecast, the key rate should therefore be cut no later than September.
I do not think Norges Bank will cut the key rate this week, but I believe that the time is ripe now. I emphasize what is happening with price developments in the eurozone countries and Sweden, and I believe much of the same will happen in Norway.
I therefore believe that imported inflation will be very low in the coming period.
With the US dollar on the decline, the "timing" for an interest rate cut is perhaps the best we have seen in the last two years—and even then I have included a lot of uncertainty in the calculation.
Annex:
Since March 2024, the wording of the interest rate decisions (press releases) has evolved as follows:
March 2024: “The policy rate will likely need to be maintained at the current level for some time ahead in order to bring inflation back to the 2 percent target within a reasonable time horizon.” In the press conference, the Governor mentioned that she thought September would be the month.
May 2024: “Based on the Committee’s current assessment of the outlook, the policy rate will likely be kept at today’s level for some time ahead”
June 2024: “If the economy evolves as currently envisaged, the policy rate will continue to lie at 4.5 percent to the end of the year, before gradually being reduced”
August 2024: “Based on our current assessment of the outlook, the policy rate will likely be kept at the current level for some time ahead”
September 2024: “The policy rate will likely be kept at 4.5 percent to the end of the year”
November 2024: “The policy rate will most likely be kept at 4.5 percent to the end of 2024”
December 2024: “Based on the Committee’s current assessment of the outlook, the policy rate will most likely be reduced in March 2025.”
January 2025: “The policy rate will likely be reduced in March”
March 2025: “The policy rate forecast in this Report is consistent with a decline in the policy rate to 4% by the end of the year, followed by a gradual further decline over the next years.”
May 2025: “The outlook implies that the policy rate will most likely be reduced in the course of 2025.”
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