Thursday, December 11, 2014

Norges Bank Trying To Stay Ahead Of The Curve

Norges Bank unexpectedly cut its "steering rate" today from 1,50 % to 1,25 %. It stated the following as a justification for its decision which somewhat surprised the markets (via Richard Milne -- @rmilneNordic -- at

“Growth prospects for the Norwegian economy have weakened. Activity in the petroleum industry is softening and the sharp fall in oil prices is likely to amplify this tendency. This will have spillover effects on the wider economy and unemployment may edge up ahead. At the same time, the krone has depreciated markedly, which is helping to dampen the effects on the Norwegian economy and underpin inflation.”

Some economists and other pundits, Øystein Dørum of DNB Markets and Atle Willems of EcPoFi among them, have argued that this is "wrong kind of medicine", as they expect that it might lead to increased lending to households, and higher home prices. Of all the people, I should find myself in agreement with them. And I can't say that I strongly disagree. I just don't think it's as simple as that.

I believe there's a good chance that Norges Bank is much more worried about the economy than most of us realize. One sign of this is how they today expressed their concern for the world economy:
"The upturn in the world economy remains moderate and there is considerable uncertainty surrounding developments ahead."

As of late, one of the main arguments for an expected soft landing in Norway has been the strength of world economy, a factor which, combined with a weaker Krone, is expected to help Norwegian non-oil exporters. The oil price fall has been widely interpreted as being supply-related, which would mean it would stimulate oil-importing economies. That is a dangerous over-simplification. You can never forget the demand side, and there it is expectations that matter. China, one of the main locomotives of world economy since 2008, has been slowing down for a while and this trend is expected to continue in 2015. Europe is another headache that won't go away, and it's the destination for around 80 % of Norwegian exports.

It has been suggested that today's rate cut is a sign of strong pessimism on the part of Norges Bank, and I can't but agree. To be fair, Dørum of DNB says that if credit growth would slow down substantially, then a rate cut could be the right choice. Whereas he would like to see more evidence before the cut, Norges Bank has decided to act already on the expectation of much slower credit growth. In other words, it's trying to do "whatever it takes" (please, Mr. Olsen, don't ever use those words...) to stay ahead of the curve.

I see also a human factor behind this decision. This might come as a revelation for some of the readers, but central bankers are human beings like the rest of us. To better understand what they might be thinking at Norges Bank, I suggest you read this article from the Financial Times: "Central banks: Stockholm syndrome". It shows how Sweden's Riksbank, and especially its head Stefan Ingves, has been crucified -- by Paul Krugman and the likes -- for too tight monetary policy, the aim of which was to fight credit growth and higher home prices. I do recognize that the inflation and unemployment situation is different in Norway at the moment. But so is it with GDP growth (6,6 per cent in Sweden back in 2010!) and the expectations thereof. My point is a broader one: In the current environment, the prevailing (academic) opinion -- which I disagree with -- makes it very likely that central bankers will get punished for anything that in retrospect turns out to be too tight monetary policy. This has happened to Riksbank under Ingves in 2010 and the ECB under Trichet in 2011.

 Whether we like it or not, the "easing bias", much critized by the Bank for International Settlements, is still there. But I can live with a 0,25 point cut, which I don't expect to be enough to keep the credit flowing freely to households now that the severity of the economic situation is finally dawning on the public. Should I find myself mistaken on this one later, I promise to curse today's rate cut!

UPDATE: Olsen puts it like this at Bloomberg:

“Our job now is that we need to prevent a severe downturn in the economy”

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