Upward Rate Risks in Norway and Australia

May 28, 2008

Norway’s central bank, the Norges Bank, kept its benchmark rate unchanged at 5.5% after a policy meeting today. That’s right in the center of a 5-6% range that officials had expected to be observed during 1H08. A statement released today explained why there was no immediate follow-up to April’s 25-basis point tightening but reaffirmed that a bias toward a more restrictive monetary stance remains in place:

“The increase in inflation and the prospect of higher inflation suggest a further increase in the key policy rate. Against the background of the turbulence in financial markets, high premiums in the money market and uncertainty about the global economic outlook, it is nevertheless appropriate to leave the key policy rate unchanged now.” The statement puts underlying consumer price inflation currently at somewhat more than 2.5% and observes continuing high capacity usage despite some evidence pointing to more moderate growth such as declining building starts and lower foreign growth prospects. The warning about a possible need for further restraint keeps a rate hike in late June in play.

Over in Australia, the story is similar. A slowdown in growth is clearly underway, with the PSI services index dropping from 51.8 in March to 48.9 in April, retail sales declining by 1.2% in 1Q08, and home sales at a 16-year low. But the issue is whether growth will slow as much as officials at the Reserve Bank of Australia feel is needed to curb inflation down to its target. Consumer confidence picked up in May, and most importantly, leading indicators of business investment show resilience. Construction spending advanced by a solid 2.3% in 1Q08, and the labor market is not retrenching as much as assumed. The Aussie cash rate is high already at 7.25%, and many more months will pass before officials decide whether monetary policy is tight enough. I expect a rate hike to occur sooner in Norway than Australia, but the next change in both countries is more likely to be an increase than a decrease.



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