The objective of monetary policy
The Government has defined an inflation target for monetary policy in Norway. Norges Bank's operational conduct of monetary policy is oriented towards low and stable inflation. The operational objective for monetary policy is annual consumer price inflation of approximately 2.5 per cent over time.

Monetary policy influences the economy with long and variable lags. Norges Bank sets the interest rate with a view to stabilising inflation at the target within a reasonable time horizon, normally 1-3 years. The more precise horizon will depend on disturbances to which the economy is exposed and how they will affect the path for inflation and the real economy ahead.

In general, the direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties and extraordinary temporary disturbances are not taken into account. Norges Bank places particular emphasis on CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) when assessing underlying inflation.

Previous assessments
The Executive Board decided on 11 August 2004 to leave interest rates unchanged at 1.75 per cent. The interest rate was last changed on 11 March 2004, when it was reduced by 0.25 percentage point.

In Inflation Report 2/04, presented on 1 July, mainland GDP growth was projected to pick up markedly this year and remain relatively high next year. The output level will be slightly higher than implied by the trend level, i.e. the output gap is projected to be marginally positive in the period 2005-2007. Inflation, as measured by the CPI-ATE, is expected to rise towards the end of the year and to show a moderate increase in the period 2005-2007. In the baseline scenario in the report, inflation remains below target up to summer 2007. Norges Bank indicated that monetary policy should be oriented towards pushing up inflation at a somewhat faster pace than projected. The monetary stance is therefore expansionary.

The Executive Board's assessment in July was that the economic outlook implies a sight deposit rate in the interval 1¼ - 2¼ per cent at the beginning of November 2004. The Executive Board also indicated that uncertainty concerning the effects of previous monetary policy easing and the unusually low interest rate imply that we should exercise caution with regard to further interest rate reductions. Given the prospect of continued low inflation for a period ahead, wide deviations from projected economic developments would be required before the interest rate should be increased within the strategy period:

Economic developments
The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting:

• Growth in total output among our trading partners slowed in the second quarter of 2004, after having expanded since the first quarter of 2003. The slowdown was particularly pronounced in Japan, but also in evidence in the US. In the euro area, growth continued at a moderate pace. On the other hand, the economic upturn gained momentum in the UK and Sweden.
• Inflation in the US and the euro area, adjusted for the effects of higher energy prices, has stabilised in recent months, after rising earlier this year. Key rates have been raised by 0.25 percentage point since the middle of August in the US, Canada, Switzerland and New Zealand. The central bank of Iceland has increased its key rate by 0.5 percentage point. Financial market expectations of a gradual interest rate increase in many countries are broadly in line with the expectations prevailing around the previous monetary policy meeting. Equity prices in the US, Europe and Japan fell in July and the first weeks of August, but have since edged up.
• Oil prices have hovered above USD 40 per barrel. High global oil demand and very low excess production capacity are contributing to high oil prices. Oil prices also reflect production disruptions in Iraq.
• Inflation in Norway has been low. Consumer prices adjusted for tax changes and excluding energy products (CPI-ATE) rose by 0.1 per cent in the year to August 2004. Even though prices for imported consumer gods measured in foreign currency are now rising and the effective krone exchange rate has been fairly stable, prices for these goods, as measured in the CPI in August, fell more than in previous months. Adjusted for the interest rate's direct effect on house rents and changes in day-care rates, the year-on-year rise is estimated at ½ per cent. In the past three months, inflation has been lower than projected in Inflation Report 2/04. According to TNS Gallup's expectations survey, inflation expectations two years ahead have been reduced, while inflation expectations five years ahead are stable at a little less than 2½ per cent.
• The krone exchange rate, as measured by a broad index (I-44), has not exhibited a clear trend since spring, but has probably been supported by high oil prices. Since the previous monetary policy meeting, the krone has depreciated by about 1 per cent.
• In Norway, market interest rate expectations were lowered after publication of the CPI for august. Forward interest rates indicate that the market expects an increase in the key rate next summer. The interest rate differential against trading partners is expected to remain negative up to 2007. TNS Gallup's third-quarter survey indicates that business leaders and households have lowered their interest rate expectations for the next twelve months.
• The Norwegian economy is expanding at a solid pace. According to preliminary figures from Statistics Norway, mainland GDP grew by 3.7 per cent between the first half of 2003 and the first half of 2004. Mainland growth primarily reflects increased activity in retail trade, the construction sector and service industries. Imports are rising sharply. There are prospects of continued strong growth in petroleum investment next year. Employment is rising moderately. The number of vacancies has increased in recent months, and registered unemployment edged down in August, adjusted for normal seasonal variations. According to TNS Gallup's business sentiment survey, business leaders consider profitability to be better than it has been for a long period. Household sentiment concerning personal finances and the national economy became increasingly positive over the summer.
• House price inflation is high. Residential construction is expanding at a fast pace. Commercial building starts have also picked up, particularly in retail trade. Rents for office premises have been stable in recent months.
• Household debt accumulation is high. Credit demand in the enterprise sector is low, but may be on the rise.

The outlook and risk factors
New information that has emerged since the previous monetary policy meeting indicates that growth in the Norwegian economy will be somewhat stronger in the period ahead than projected in Inflation Report 2/04. Survey results indicate higher investment in the oil and gas sector. Interest rate expectations are lower.

The rise in prices in the twelve months to August was lower than projected in the previous Inflation Report. Prices for clothing and footwear continued to decline at a faster pace than expected. Low retail prices for such goods may be attributable to structural changes in retail trade, intensified competition and a shift in trade patterns. The fall in clothing and footwear prices is nevertheless more pronounced than in comparable countries. The low rate of consumer price inflation also reflects a slower rise in house rents and a marked fall in the rate of increase in food prices.

The depreciation of the Norwegian krone through 2003, the low interest rate level and solid growth in the real economy may gradually push up inflation. Price developments in recent months have nevertheless increased the risk that inflation will remain low for a longer period.

Furthermore, the Executive Board would place particular emphasis on the following factors:

• There is considerable uncertainty as to the effects on prices and growth in production capacity as a result of the structural changes we have observed in many goods and services markets.
• Investment in the petroleum sector may be higher in 2005 than assumed earlier.
• The effects of high oil prices on global economic growth and externally generated price impulses may have a direct or indirect impact on the Norwegian economy. High oil prices do not appear to have made any considerable contribution to raising inflation expectations, but may curb economic growth in other countries. Lower growth in the world economy may restrain the rise in international interest rates.
• In periods, high oil prices and unrest in the Middle East result in rising demand for the Norwegian krone. Higher central government foreign exchange earnings are, however, invested in foreign securities through the Government Petroleum Fund and therefore do not have a direct impact on balance in the Norwegian foreign exchange market.

Assessment
Particular weight must be given to factors that may delay an increase in inflation. The exchange rate, long-term inflation expectations and the growth and inflation outlook in other countries have shown little change in recent months. However, inflation in Norway has not increased in line with projections. Markedly lower-than-projected inflation may, if this reflects structural changes in the goods and service markets, indicate lower inflation also over a period ahead. In isolation, this points to an easing of monetary policy.

In the conduct of monetary policy, emphasis is also placed on avoiding imbalances in the real economy. There are signs that growth in the Norwegian economy may be somewhat stronger than projected. Intensified competition in many product markets and a high degree of flexibility in, for example, the construction sector will probably reduce the likelihood of abrupt and pronounced increases in wage and price inflation in the near term. Developments in aggregate demand nevertheless warrant caution with regard to further interest rate reductions. The household debt burden is high and rising, but the interest rate burden is moderate owing to low interest rates. Signs of rising credit demand in the enterprise sector increase the risk that overall credit growth may gradually reach an excessive level.

Prospects of continued low inflation in Norway imply that Norway should not be the frontrunner in relation to other countries in setting interest rates at a more normal level.

Summary
Low price inflation in recent months points, in isolation, to lower interest rates, but there are also signs that growth in the Norwegian economy may be somewhat higher than projected. The Executive Board has concluded that it is appropriate to leave the interest rate unchanged at present. In reaching its decision, the Executive Board has weighed the objective of bringing inflation back to target and stabilising inflation expectations against the risk that output growth may eventually by too high.

Charts - monetary policy meeting (698 kB)
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Charts - monetary policy meeting (185 kB)