Norway raises interest rates, eyes turn to Fed

The Norges Bank continues with its tightening campaign. Bloomberg reports:

Norway's central bank raised its benchmark interest rate and said rates will be lifted more than previously forecast as widespread labor shortages threaten to boost wage growth and fuel inflation.

The bank increased the deposit rate by a quarter point to 4.5 percent. The rate will average 4.5 percent this year and 5.75 percent in 2008 and 2009, the bank said, lifting a previous forecast by a quarter-point this year and half a point for the next two years. In 2010, the bank sees the rate at 5.5 percent.

Elsewhere in Europe, Paris-based Insee reported yesterday that its index of sentiment among French manufacturers advanced to 110 from a revised 108 in May.

However, in the UK, consumers are reportedly feeling the effects of higher interest rates as a Confederation of British Industry survey found that retail sales slowed more than expected in June while data from the British Bankers' Association showed that mortgage approvals fell four percent in May from a year earlier.

The data from Japan continues to be mixed. Retail sales climbed 0.1 percent in May from a year earlier, the first gain in eight months, but industrial production unexpectedly dropped for a third month in May, falling 0.4 percent from a month earlier.

Today the FOMC makes its decision on interest rates with the knowledge that orders for US durable goods fell in May. Bloomberg reports:

Demand for goods meant to last several years fell 2.8 percent, the first drop in four months, after a revised 1.1 percent gain in April that was larger than previously estimated, the Commerce Department said today in Washington. Excluding transportation equipment, orders dropped 1 percent.

What remains uncertain, but could prove more important for monetary policy in the long run, is the US economy's long-term potential growth rate. From another Bloomberg report:

Federal Reserve policy makers disagree with their own staff economists, and a growing chorus on Wall Street, who say the U.S. economy can't expand as fast as it used to without pushing up prices.

The split, signaled in the minutes of May's Federal Open Market Committee meeting, may reflect debate over whether a slowdown in U.S. productivity is permanent. "Many" FOMC members were "somewhat more optimistic" than lower-ranking officials about the economy's speed limit, the records showed.

Also interesting would be if the FOMC starts to emphasise the headline inflation rate rather than the core rate, as Krishna Guha suggests in the FT.

Federal Reserve officials are expected to discuss ways to redirect market attention from current core inflation to its forecast of headline inflation at this week’s meeting of the rate-setting Open Market Committee...

Officials worry that their emphasis on current core inflation might have led the market to put undue weight on these monthly inflation figures.

Policy is forward-looking, and officials are focused on their forecast of where headline inflation will be in one or two years, not where core inflation was last month.