Norges Bank's rate decision may or may not have been justified, but the Bank's rhetoric confuses the market and undermines confidence in monetary policy and ultimately in price stability itself.
Prospects for both growth and inflation were stronger in the Q1 regional network report than previously expected, and prospects are probably stronger than what is assumed in Norges Bank's downside scenario. The relatively upbeat report points to no interest rate cut in March.
In his annual address, Governor Øystein Olsen argued against using the interest rate to bring inflation quickly back to the target. The Governor's somewhat surprising statements make further interest rate cuts seem less likely.
Given the weak outlook for the eurozone, we believe Norges Bank's low interest rate scenario from Monetary Policy Report 3/11 is too optimistic. We therefore believe the key policy rate will be cut by 25bp both in March and June next year, leaving the policy rate at 1.25% until well into 2013.
Given the weak Regional Network Report for Q4 and two sequential interest rate cuts from the ECB, we now expect Norges Bank to cut the interest rate by 50bp on Dec. 14. Hopefully Norges Bank will, as it did in December 2008, present its updated analysis in a short update to the monetary policy report with a new interest rate path.
We expect that the Norges Bank Regional Network report for Q4, due this Friday, will show softening business conditions for Norwegian firms. A sufficiently weak report will probably lead to an interest rate cut of 50bp from Norges Bank.