Interest rate hikes are nearing

(04.04.2011) The Norwegian labour market is improving and house prices have risen to a record high. Due to the strong development in the Norwegian economy, the probability of an interest rate hike in May is increasing.

By Camilla Viland, Analyst at DNB Markets

DNB markets dealingroom in osloProspects of rate hikes and a high oil price is benefiting the Norwegian krone. The euro has also strengthened due to expectations of higher interest rate hikes. ECB is expected to raise its key policy rate by 25 basis points on Thursday.

According to figures released on Friday, the registered unemployment in Norway decreased by about 2500 persons (seasonally adjusted) in March. This was the fourth straight monthly decrease and the number of unemployed is at its lowest level since late 2009. Gross unemployment (incl. persons on labour market measures) fell by 1700, vs. an expected decrease of 900. The unadjusted unemployment rate fell from 3.0 to 2.9 per cent (as expected).

Norwegian house market figures were also better than expected. House prices grew by 1.0 per cent in March (seasonally adjusted) and are now at record high levels. The level of house prices is 9.5 per cent higher than one year ago. The trend in the house market has been very strong lately.

Norges Bank has lately said that the consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat in the future ahead suggest that the key policy rate should be increased in the near term. Furthermore their latest interest rate forecast suggests a 50 per cent probability of an interest rate hike already in May. Even if house price growth has been strong we have so far only seen moderate increases in household's credit growth.

However developments in credit growth tend to lag developments in house prices. Thus, if house prices continue to rise and consumption growth also picks up it is likely that credit growth will increase going forward. Last week's Norwegian key figures (stronger house price and consumption growth than expected) increase the probability of an interest rate hike in May. This is probably one reason why the Norwegian krone strengthened towards the end of last week. A higher oil price have probably also been positive for NOK.

While the probability of an interest rate hike in Norway seems to be increasing, markets are more uncertain regarding what Bank of England will do. Inflation is high and as a result the British central bank has indicated that rates could be hikes. The economic recovery is however showing signs of fatigue. The manufacturing CIPS index released on Friday also highlighted this. The index fell from 61.5 to 57.1. Consensus had expected an outcome of 60.6. After a strong start to the year, British manufacturing activity now seem to abate. The pound weakened immediately as a response to the figures. GBPNOK is currently trading around 8.85. Apart from a few days in March last year the currency cross has not been trading at such low levels since 1976/77.

US employment rose by 216' in March, while consensus had expected an outcome of 190'. The increase was in particular large for the service providing sector (+199'). Looking away from April and May last year, the gain was the strongest in five years. The unemployment rate dropped from 8.9 to 8.8 per cent. The level is however still high. The ISM index for the US manufacturing sector fell slightly, from 61.4 in February to 61.2 in March. Still, the index is at high levels indication GDP growth of around 6 per cent y/y. The key figures released on Friday helped lift the US stock market, but was not enough to support the dollar, at least not versus the euro. The euro still benefits from expectations of higher interest rates. ECB is expected to raise its key policy rate by 25 basis points on Thursday.