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The Bubble Forming in the North Sea

Tuesday, 9 Oct 2012 | 2:39 PM ET
Buildings in Røros, Norway
Svein Nordrum | Flickr | Getty Images
Buildings in Røros, Norway

Don't look now, but Norwegian housing prices are on a tear.

Does this sound familiar?

"Low interest rates, stable CPI inflation and booming asset prices combine to form conditions whereby debt is accumulated at a growing rate and to levels that contravene conventional rules of thumb pertaining to stability."

It could be a reference to Japan way back when, or the U.S. a lot more recently - but instead, it is Bankof New York Mellon's Neil Mellor writing about Norway.

The oil-rich nation is in the midst of a massive housing boom, and Mellor, a currency strategist, is voicing concern - not least because in his view, the central bank is not considering housing prices enough when assessing inflation risks, and therefore not adjusting policy accordingly. Officially, inflation in Norway stands at a paltry0.5%, but Mellor says that really only reflects what's happening with goods and services.

"Crises passim have taught us that formulating policy on the basis of a narrow range of prices is a recipe for potential instability, and history tells us that it is never 'different this time,'" he wrote in a note to clients. "Indeed, if anything, purported evidence of fundamental justification for a concerted rise in asset prices tends to grow in proportion to the latter’s scale." And this time, the scale is there: household debt-to-income stands at 210 percent - well above the 130 percent in the U.S. in 2007, before the housing crisis fully erupted.

What does this mean for the krone?

It could be good news.

Marc Chandler, chief currency strategist at Brown Brothers Harriman, says an interest rate hike is unlikely at Norges Bank's next meeting, given the uncertainty about the global economic outlook. However, he wrote in a note to clients, "with labor costs set to rise 4 percent next year, according to Finance Minister Johnsen, a rate hike at the December 19th meeting seems cannot be ruled out." And that would be good for the krone: Chandler expects it to continue to outperform the dollar, euro, and Swedish krona.

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