Why are you so worried about interest rates and krone exchange rates?

Why are you so worried about interest rates and krone exchange rates?

Last year, the Bank of Norway significantly raised its key interest rate. This is noticed by both companies and ordinary people who have loans. Many would probably prefer the interest rate to remain low. thats understood. Even more surprising is that the rise in interest rates was met with criticism from LO’s, among others, and was politically problematic.

A proposal was made in parliament to amend the monetary policy mandate.

After the financial crisis in 2008 and until the winter of 2022, interest rates in industrialized countries, especially in Europe, were very low, close to zero or less. This meant that interest rates in Norway were also low, although Norges Bank sometimes took advantage of the fact that Norway had its own currency to maintain a somewhat higher interest rate than our neighboring countries.

Persistently low interest rates have adverse effects on financial stability. It lures you into unsustainable loans over time, and inflates stock and real estate values. Thus lower interest rates have negative distributional effects.

Over the past year, monetary policy challenges have completely changed. In the aftermath of the Corona pandemic, the combination of strong demand growth and problems in supply chains has led to an acceleration in international commodity prices. Then came the Russian invasion of Ukraine, which has already caused energy and commodity prices to skyrocket.

The mission of central banks has been reversed. From increasing inflation, to trying to slow down accelerating inflation, which in many countries is reinforced by a high level of activity and a tight labor market. Obviously interest rates, also in Norway, in this case have to be coded from an abnormally low level at the turn of the 2022/23 year. The fact that we have finally moved away from an abnormally low level of interest rates is a positive in itself.

Rising interest rates have a dampening effect on economic activity, in part because it becomes more expensive to handle loans. A number of families are now noticing that their debts are more difficult to bear. At the same time, it is clear that the rise in interest rates occurred during the period of time that loan customers should be tested – and they should be prepared for – when they are given a bank loan.

Today’s nominal interest rate is still lower than the rate of price increases, and also less than the wage growth estimate in 2023. In this sense, the current monetary policy does not seem to be too strict.

For a small, open economy, strong fluctuations in the exchange rate create special problems for the central bank with the aim of controlling inflation. During 2023, the krone’s exchange rate weakened significantly against most other currencies.

A number of commentators have recently indicated that this will cause Norges to raise interest rates further. The Bank of Norway itself has been clear that the exchange rate is a central figure, both when assessing price expectations and with regard to developments in the real economy. But it has also repeatedly emphasized that it will not allow itself to be trapped again in a system in which monetary policy is (indirectly) governed by exchange rate developments.

A weak krone makes imported goods and services more expensive and, in the current situation, gives additional impetus to domestic price growth. But at some point you have to expect cycle development to stop or reverse. In this case, the inflationary impulses provided by the weakness of the krone may be temporary.

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If this is the central bank’s assessment, it will review the impact on price inflation caused by a weaker currency.

On the other hand, weak krone is good for the competitive part of the business world. When the price of oil more than halved in 2014, the krone weakened sharply. The drop in oil prices highlighted that over time the Norwegian economy needs more legs to stand on. Weaker krone stimulates profitability in other industries. In the years after 2014, oil prices have gone up and down, but they have not changed the picture that the Norwegian economy will have to change through the green transition.

The krone exchange rate somewhat follows oil price movements, but it is also noticeably weak during periods of international turmoil. It seems that the difference between the interest rate abroad was less significant.

In the wake of the drop in oil prices in 2014, the Bank of Norway cut its key interest rate to stimulate activity, and “support an appropriately weak krone”. The main condition for this to happen was that the parties in working life showed responsibility and did not claim compensation for further price growth as a result of the depreciation of the krone.

Today, swaps for the central bank are more demanding. Over the past year, higher import prices have passed into the prices of domestically produced goods and services. Domestically driven inflation accelerated.

This year’s collective agreement indicates a wage increase of 5.5 percent, a clear increase from what corresponds over time with a 2 percent price increase. This may mean that it will take some time to bring inflation back towards the target. It may also help explain some of the recent vulnerabilities of krone.

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In this case, it indicates that foreign exchange market players also care about the ability of Norwegian companies to compete and adapt.

DN Finance Editor: Weak krone makes us all poorer:

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Dalila Awolowo

Dalila Awolowo

"Explorer. Unapologetic entrepreneur. Alcohol fanatic. Certified writer. Wannabe tv evangelist. Twitter fanatic. Student. Web scholar. Travel buff."

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