Norway’s Central Bank Surprisingly Cuts Interest Rate To Zero, Might They Go Negative?

The central bank of Norway, Norges Bank, unexpectedly cut its main interest rate by 25 basis points to a record low of zero on Thursday as the country deals with both the coronavirus pandemic and low crude oil prices.

This action marked the Bank’s third rate cut in less than two months.

“This [rate cut] decision comes unexpected, and is not in line with consensus,” Nordea Markets said in a note.

Norges Bank said it expects Norway’s mainland economy to shrink by 5.2% this year – the largest decline since World War II. In April, unemployment in Norway exceeded 15%, the highest level in history.

“Activity in the Norwegian economy has fallen abruptly as a result of the coronavirus pandemic,” the Bank said. “The downturn is amplified by the severe impact of the pandemic on surrounding countries and by a sharp fall in oil prices.”

The Bank stressed that this extreme policy will help to prevent the crisis from worsening.

“Low interest rates cannot prevent the coronavirus outbreak from having a substantial impact on the Norwegian economy, but can help dampen the downturn,” the Bank said. “As the situation normalizes, low interest rates will support a faster rebound in activity. This may reduce the risk of unemployment becoming entrenched at a high level.”

The Bank also said it will continue its program of liquidity lending to banks through the end of August.

The Norwegian government has also offered $35 billion in business loans, tax deferments and spending to keep the economy afloat.

Kari Due-Andresen, chief economist at Handelsbanken of Sweden, said the rate cut was necessary due to the “historically deep downturn” Norway’s economy is undergoing.

The Bank further expects the Norwegian economy to rebound by 3% next year.

“Activity in the economy is expected to pick up as containment measures are eased. But it will likely take time for output and employment to return to the levels prevailing before the pandemic,” Bank Governor Oystein Olsen said.

Last month, the Oslo government said it will cut its offshore oil production in order to help stabilize global oil markets. Specifically, Norway will reduce production by 250,000 barrels per day in June and by 134,000 barrels per day in the second half of 2020. Moreover, the commencement of production of several oilfields will be postponed until 2021.

Pushing the main interest rate to zero raises the question of a further drop into uncharted waters.

However, most analysts do not expect the central bank to cut rates further into negative territory.

“This is it in terms of rate cuts, in our view,” said Johanna Jeansson of Bloomberg Economics. “Norges Bank sets out to keep financial markets functioning, but it will be up to the government to get the economy going once the pandemic loosens its grip.”

Capital Economics wrote in a note: “Given that Norges Bank has established a reputation for doing exactly what it says, we have removed the further [25 basis point] cut that we had penciled in for the June meeting. As a result, we now expect interest rates to remain rooted at zero until 2022 at least.”

Olsen himself said that based on the Bank’s “current assessment of the outlook and balance of risks” the main interest rate “will most likely remain at today’s level for some time ahead. We do not envisage making further policy rate cuts.”

Still, Olsen did not completely rule out the possibility of negative rates.

“The way we see things going forward, we don’t foresee any further rate cuts. But then we add that ... the committee is especially focused on having well-functioning financial, including money, markets. So nothing is dismissed,” Olsen said.

Norway’s neighbor Denmark, as well as Switzerland, have had negative interest rates for years at minus-0.75%.

When interest rates are negative, it means that banks and other lenders have to pay to keep their excess reserves stored in the central bank instead of receiving positive interest income.