It did not go as badly as many feared: After a year and a half of pandemic, stock prices are at a record level. There were fewer bankruptcies. Fewer people lost their jobs than feared.
Low interest rates have meant that many have saved a lot of money.
But in a report on the future, Finanstilsynet sees potentially very dark clouds on the horizon: They fear it has now built up to a real crisis where almost everything collapses at once:
– In the stress scenario, it is assumed that global capacity problems on the supply side and pent-up demand as a result of the shutdown measures, lead to increased inflation and higher key interest rates internationally. This leads to increased inflation and interest rates also in Norway. Money market interest rates and risk premiums rise, and securities and real estate prices are falling sharply. Inflation remains high, and the interest rate level does not decrease until towards the end of the projection period. This leads to sharp decline in economic activity and significant loan losses, says Director of Financial Supervision Morten Baltzersen about the report.
This is the fear: Housing rent over 7 percent
What the authorities fear is that a domino effect that strikes the entire society on the way out of the pandemic. The background is that through the pandemic has built up huge amounts of money, which in reality has not been able to use for anything. When the measures are now eased, everyone will use the money, but the supply lines are down.
The one who bids the most gets access to the limited resources. This gives a sharp increase in inflation:
– Foreign inflation is expected to rise from 0.2 per cent in 2020, reaching 4.5 per cent already in 2022 and increasing further to 4.8 per cent in 2024. It will decline somewhat in 2025, but is still well above the central banks’ inflation target. Rising inflation is being met with interest rate hikes by central banks. Interest rate rises and increased uncertainty about economic developments lead to a sharp rise in market interest rates internationally. Inflation will stabilize and fall somewhat only in 2025. The key interest rates and market interest rates will therefore remain high for a long time. In Norway, inflation will increase from 1.3 per cent in 2020 to 4.0 per cent in 2024. In the same period, the Norwegian money market interest rate (3-month Nibor) will rise from 0.7 to 6.2 per cent.
This has a direct effect on the mortgage:
– The banks’ average lending rate will increase from 3.0 per cent in 2020 to 7.1 per cent in 2022. Such an interest rate increase will have major consequences for Norwegian households as a result of the high level of debt and because about 95 per cent of household debt has floating interest rates.
– The interest burden on households will increase from 5.7 per cent in 2020 to 15.6 per cent in 2023. This is higher than the interest burden during the financial crisis, but lower than the level during the banking crisis in the early 1990s. The interest burden will decrease to 13.9 percent in 2025
Interest burden is how much of your salary payment you have to use to pay interest on the debt. In addition, the installments themselves. For companies, the debt burden increases from 7.6 to 18 percent.
– High debt, higher interest rates and weak income growth among households lead to a sharp tightening of private consumption, which will fall by a total of about 9 percent from 2021 to 2024. This contributes together with weak development in real investment and exports of traditional goods and services to very weak development in economic activity in Norway. Mainland Norway’s GDP will fall by 5.3 per cent from 2021 to 2024, see Chart 5.1. Unemployment (LFS) will increase from 4.6 per cent in 2020 to 6.9 per cent in 2024, see Chart 5.2.
Collapse in real estate prices and the stock market
A consequence of this is that prices are collapsing in the real estate market:
– Calculated as a change in annual averages, house prices will fall by 36 per cent from 2021 to 2024 and commercial real estate prices by 45 per cent, Finanstilsynet writes.
They compare the crisis in the late 80s, where house prices fell by 24 percent.
According to Finanstilsynet, the consequence is that the banks lose massively on loans, primarily to companies. They estimate that losses will increase from 0.9 to almost 5 percent
– Banks’ losses on lending to both individuals and companies increase in the stress scenario, but the losses increase the most and are greatest in the corporate market. Accumulated losses on loans to companies amount to 12.6 per cent of loans throughout the projection period. For loans to individuals, accumulated losses are 4.3 per cent during the period. The losses in the stress scenario are high, but clearly lower than the banks’ losses during the banking crisis in the early 1990s, they write.
The reason for the large losses is simply that companies do not have high enough earnings to pay off their loans:
– A relatively large proportion of non-financial corporations are not able to cover total interest expenses on bank loans, bond loans and accounts payable, etc. with current earnings
According to Finanstilsynet, this will have a “significant” effect on the banks’ solvency, and they will violate the requirements for core capital, but will probably not completely break the backs of the banking groups.
– It has really only happened once before
Chief economist Harald Magnus Andreassen in Sparebank 1 Markets believes what Finanstilsynet describes can happen.
– There is a much greater risk associated with real estate and debt than there is with shares. We have had many stock crashes in history, and the fact that the Nasdaq index is falling alone is not a big problem. Normally, there is little debt associated with shares, so it does not create the same downturn as real estate price falls do. Commercial buildings and housing are extremely heavy. It has happened in all countries, and it happens at irregular intervals.
– It happens after periods where it has been easy to borrow a lot and where the prices have been offered. People who felt rich were not so rich after all. We have many examples of this. This causes the whole economy to collapse, because those who are affected by the fall in property prices will try to compensate for this by repaying their debt. Thus, they spend less, savings rise, and it spreads to the rest of the economy and there are many unemployed. Therefore, it is important that Finanstilsynet makes such calculations.
– What Finanstilsynet writes is no impossibility, and it is the same as we saw in the 60s. Then inflation was high, eventually interest rates came up, and then things went sour for real estate and shares.
However, he considers the probability of this to be small:
– I think the big ugly thing is what we call stagflation, the fact that the economy is in reverse and unemployment is rising, at the same time as inflation remains high and wage growth remains high. I really think that the risk that we get the combination of a poorer economy and high inflation in something more in a very short time is small.
– What we see is that wage growth reacts in all countries. It may be an oil price or other commodity that rises for a period, but it does not rise for long – and at least not in a bad economy. The risk that we get a classic stagflation with poor growth and high inflation at the same time is not very great. This means that scenarios where unemployment is high, inflation is high and interest rates are even higher are very unlikely.
Fear prevents this from happening
Much of the reason is that the fear that it will happen can prevent it from happening:
– What we see in the US and Norway is that the central banks say that “we will keep interest rates low and continue to buy bonds, but we will soon start discussing when to stop.” The interest rate curve of the Fed in the US has been raised significantly from spring to summer. Norges Bank will take four interest rate jumps in a row. The reaction in the US was that long-term interest rates fell, and inflation fears fell, because the central bank said that there was a certain risk of inflation here. When the central bank acknowledges this, the risk of it getting out of control is less. Thus, long-term inflation expectations fall, he says.
– There is always a small square down in a corner that says that everything that can go wrong goes wrong at the same time. But I think it is more likely that price and wage growth will come down fairly quickly. Then you do not get a period of high interest rates at the same time as unemployment rises. The probability of having a weak economy and low interest rates is much greater than unemployment and at the same time high interest rates. It is conceivable, but then a lot has gone wrong for a long time.
– It is really only once this has happened before: Inflation usually comes after wars, and then we had bad politics in the 60s, says the chief economist.
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