Norwegian and British Central Bank Rates on Hold for Now

August 13, 2008

Earlier today, the Norges Bank announced a decision to leave its key policy rate at 5.75%, while the Bank of England quarterly inflation report was released, projecting a sharp near-term rise of CPI inflation to 4.8% but sub-target inflation by 2H10 if the British Bank Rate were to stay at its current level of 5.0%.  The near-term implication of this new information is that there is unlikely to be an imminent policy change by either of these central banks but that over time, policy will chart a more restrictive course in Norway than in the United Kingdom.  That makes sense, since Norwegian growth is likely to hold above 2% into 2009, whereas the Bank of England now projects a rise in British GDP of just 0.1% in the year to 1Q09, down from a forecast of 1.0% made three months ago.

The Norges Bank statement today concedes a marked slowdown in global growth and a more moderate slowing of activity in Norway.  Nonetheless, inflation is “rising,” with a core rate approaching close to 3.5%, a full percentage point above target.  High capacity utilization and a tight labor market are mentioned in the statement as factors countering the price-dampening effects of slower growth.  The statement explicitly endorses the central bank rate outlined in June, which points to even odds between the rate holding at 5.75% or peaking at 6.0% sometime over the coming year.

The British message is more confusing than the Norwegian one.  Growth has been revised downward, and officials see a possibility of recession with negative GDP growth over 1 or 2 quarters.  Risks surrounding the growth prognosis are skewed to the downside, so the streak of down quarters could conceivably extend beyond two.  If policy is not eased, the baseline projection points to sub-target inflation in the medium term.  However, inflation is heading upward sharply in the near term, and that poses a risk of lifting expectations of future inflation, which already appear to be creeping higher.  The report mentions a 3.8% current inflation rate, but that figure is now history with yesterday’s report of higher-than-expected 4.4% inflation.  All this suggests that inflation may crest above the level assumed by officials.  Their thinking is to wait for that topping out before beginning to ease.  Inflation this year has consistently surpassed the BOE forecast despite lower-than-assumed wage and labor market pressure.  There are only four more Bank of England meetings in 2008.  November seems the earliest prudent time that we might see a rate cut, and a move could be delayed further if inflation, expected inflation, commodity market developments and the rate of sterling depreciation do not cooperate.  By the same token, it would not be shocking either — but rather only surprising — if officials jump the gun and act in a recession but before inflation has crested.  Bank of England policymaking relies less on consensus building than the credit policy decisions of the ECB or BOJ.  Nine people, all independent thinkers, sit on the Monetary Policy Committee.  Decisions are made by majority vote.  The Inflation Report out today admits that “there is a range of views among the Committee on both the central projection and the balance of risks” for inflation.  Clearly then, opinions will behave very fluidly as new data and market developments emerge, both on an individual-by-individual basis and in terms of how those nine independent views weave together into a group decision.

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