Real GDP contracted at a modest rate in the first quarter. However, overall GDP was propped up by the oil sector, and domestic demand was very weak. Moreover, the large increase in inventories in the first quarter could potentially weigh on GDP growth in the current quarter.

Underlying Norwegian Economy Weaker than the Headline Suggests

Real GDP in Norway declined at an annualized rate of 1.8 percent in the first quarter of 2009 relative to the previous quarter. In light of the economic meltdown occurring in Europe-real GDP in the Euro-zone plunged nearly 10 percent in the first quarter-the contraction in the Norwegian economy seems fairly small by comparison.

However, the oil sector plays an important role in the Norwegian economy, and the 4.7 percent rise in petroleum production in the first quarter helped to flatten the overall GDP result. Mainland GDP, which excludes the petroleum sector, contracted at an annualized rate of 3.9 percent. On a year-over-year basis, mainland GDP fell 0.9 percent, the weakest pace of growth since 1990 (see middle chart).

Like most other countries, exports in Norway tanked in the first quarter, dropping about 18 percent relative to the previous quarter. Final domestic demand was also very weak. Personal consumption expenditures slid 0.8 percent, and fixed investment spending tumbled 25 percent. If not for the rise in government spending, the Norwegian economy would have contracted even more than it did. In addition, a sizeable increase in inventories helped to boost overall GDP growth in the first quarter, but it probably will weigh on economic activity in the second quarter as businesses cut production in order to work off excessive stocks. Indeed, the economy ended the first quarter on a weak note as manufacturing production in March declined 0.6 percent relative to the previous month. Moreover, the purchasing managers' index for the manufacturing sector in April remained well below the demarcation line that separates expansion from contraction. In other words, it appears that the Norwegian economy has contracted further in the second quarter.

In response to the weakness in the Norwegian economy, Norges Bank (the country's central bank) has reduced its main policy rate by 425 bps since October, including its most recent 50 bps rate cut on May 6. Although Norges Bank has room to ease further if conditions warrant, it is probably in a wait-and-see mode for the time being.

The Norwegian krone depreciated sharply last autumn as global economic activity nosedived in the wake of the Lehman Brothers debacle (see middle chart). However, it has recouped some of its losses this year as the global economic outlook has become less dire. In our view, both the Norwegian economy and the overall global economy will remain very weak throughout most of 2009. Therefore, we look for the krone to depreciate a bit vis-à-vis the dollar through the end of the year, but it should appreciate on a sustained basis next year as global economic activity strengthens.