Sizable Rate Cuts in Norway and Iceland

October 15, 2008

Declaring global credit channels “dried up” and growth prospects “considerably worsened” and adding that Norwegian funding costs and availability have respectively risen and dropped, the Norges Bank reduced its key policy rate by 50 basis points to 5.25%.  The size of the cut matched consensus expectations. The policy review came earlier than scheduled, but the next planned meeting on October 29th was not canceled.  When policymakers met three weeks ago on September 24th, they had not expected their rate to climb down to 5.25% until 2010 because of high inflation and confidence then that growth would stay decent.  However, real GDP is now expected to be low and perhaps totally zero for the next few quarters.  That shifting prognosis is associated with diminishing “forces that have fueled inflation.”  Today’s statement suggests that more rate cuts in 2008 are likely but is non-committal about the October 29th meeting other than to say that a full report will be released then.  Such reports typically provide forecasts for growth and inflation as well as expected guide paths for interest rates.  The 50-basis point rate cut reverses rate hikes of 25 basis points each on April 23rd and June 25th, which had been the 15th and 16th increases from a low of 1.75% that prevailed between March 2004 and mid-2005.

No economy has been slammed more harshly by the global credit market crisis than Iceland’s, and it shows in today’s decision by the Central Bank of Iceland to slash its policy rate to 12.0% from 15.5%.  Similar to Norway, Iceland’s rate reduction represents a trend reversal.  The previous two moves in 2008 had been increases of 125 basis points on March 25th and of 50 basis points on April 10th, tightenings that were implemented in response to higher-than-forecast inflation, rising expected inflation, and steeper-than-anticipated krona depreciation.  The new 12% level is the lowest since 11.5% prior to May 18, 2006 and is also two percentage points below the 14.0% on-year rate of CPI inflation in September.  A statement released by Iceland’s central bank candidly called the banking system in a state of collapse, demand to be down “precipitously,” and observed “a variety of jobs disappearing virtually in the blink of an eye.”  The central bank meets next in three weeks on November 6th.  Whether another easing occurs as soon as then in spite of today’s dramatic 350-bp reduction will be contingent upon the evolution of Iceland’s financial and real economic crisis. I attach even odds that officials are compelled to act again at that time.


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