Output growth is high and may in isolation suggest a more rapid increase in the interest rate ahead. This would reduce the risk of bottlenecks in the economy with rising cost inflation and continued debt build-up. On the other hand, raising the interest rate more rapidly would increase the risk of a stronger krone, which could counter an increase in inflation towards the target of 2.5 per cent.

Interest-rate setting since this spring has been oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. On the basis of the analysis in the Inflation Report, this strategy still appears to provide a reasonable balance between the objectives of monetary policy that are to be safeguarded by Norges Bank.

The monetary policy strategy in Inflation Report 3/05 is that the sight deposit rate should lie in the interval 2-3 per cent in the period to the publication of the next Inflation Report on 16 March 2006, conditional on economic developments that are broadly in line with the projections.

Outlook and risk factors

The projections in Inflation Report 3/05 are based on an interest rate path that in the view of the Executive Board provides a reasonable balance between the objectives of monetary policy. The projections imply a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. In the analysis, it is assumed that money market rates among our trading partners also increase gradually over the next three years. Exchange rate movements are difficult to project. The interest rate path in Norway and abroad may be consistent with an approximately unchanged krone exchange rate.

With this interest rate path, CPI-ATE inflation is projected to increase gradually from about 1½ per cent today to close to 2 per cent at the beginning of 2007. Inflation is likely to increase further and reach the target of 2½ per cent in 2008. Continued low interest rates will probably contribute to above-trend output growth again in 2006. The output gap, which is a measure of capacity utilisation in the economy, is estimated to be positive this year and increase further in 2006. A gradual increase in the interest rate towards a more normal level will probably result in lower growth in demand for goods and services after a period. Capacity utilisation may in time be brought down somewhat from a high level and stabilised. This will curb the rise in inflation, so that it stabilises close to target.

The Executive Board would place particular emphasis on the following factors of uncertainty:

• Stronger trade shifts and increased labour market competition may result in lower price and wage inflation and weaker pressures in the economy. This would then imply, in isolation, less frequent interest rate changes.
• We have little experience of such low interest rates over a long period. There is a risk that an interest rate that is kept low for a longer period may lead to expectations of a persistently low interest rate. This may result in a higher-than-projected rise in output and inflation and would in isolation suggest a faster interest rate increase.
• Developments in the global economy are uncertain. Our projections are partly based on favourable growth prospects for other countries and continued high oil prices. Alternative developments for international growth and oil prices may result in a path for the Norwegian economy that differs from the one projected.

Economic developments

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

• Output growth remains buoyant in the US and appears to be increasing somewhat in Sweden. In the euro area, there are still few signs of a pick-up in domestic demand. Various confidence indicators nevertheless suggest growing optimism in enterprises, as is the case in Germany. Activity seems to be slowing more than expected in the UK. Growth in most newly industrialised countries in Asia remains strong. In Japan, it appears that developments were weak in the third quarter, but there are expectations that private demand will pick up ahead.
• There are clear signs that consumer prices are increasing more rapidly in the US, the UK and to a certain extent in the euro area. So far, high energy prices have had little impact on other consumer prices.
• The central banks in the US, Canada and New Zealand have all increased their key rates by 0.25 percentage point since our previous monetary policy meeting. Market interest rate expectations have risen in a number of countries. An increase in the interest rate is expected in the course of the next three months in the US, Canada, the euro area, Switzerland and New Zealand. International long-term interest rates have increased. Equity prices have remained high in Europe and the US, but have fallen in Japan.
• Both oil spot prices and oil futures 6-7 years ahead have fallen somewhat, but remain at a high level.
• The year-on-year rise in consumer prices adjusted for tax changes and excluding energy products (CPI-ATE) was 1.3 per cent in September. Adjusted for the direct impact of interest rates, which have pushed down house rents, inflation was 1.5 per cent. Adjusted for tax changes alone, inflation (CPI-AT) was 1.7 per cent. The rise in the overall consumer price index (CPI) was 2 per cent.
• As measured by the import-weighted exchange rate index I-44, the krone exchange rate is now at approximately the level prevailing at the time of the previous monetary policy meeting.
• Market interest rate expectations have risen somewhat since the previous monetary policy meeting. Interest rates in Norway are expected to be higher than for an average of our trading partners from the beginning of 2006, although the interest rate differential is not expected to be particularly wide. Long-term Norwegian interest rates have risen.
• The benchmark index on the Oslo Stock Exchange has fallen markedly since the beginning of October, with equities in the energy sector showing the sharpest decline.
• Statistics Norway's Labour Force Survey shows that employment growth has edged up in recent months. The contacts in Norges Bank's regional network reported growth in employment in the business sector in August and September. A larger share of contacts in our regional network are considering recruiting new employees and fewer are considering reducing their workforces. Unemployment, as registered by the Directorate of Labour, is still falling.
• Manufacturing production and new commercial building starts are still on the rise. Statistics Norway's business tendency survey for the third quarter indicates that growth in output and capacity utilisation in manufacturing will continue in the fourth quarter. Total debt for mainland enterprises has increased. These enterprises' liquidity holdings in the form of bank deposits were 18.4 per cent higher in September than one year earlier.
• Household consumption of goods fell in September. At the same time, debt accumulation is rising. As a percentage of disposable income, household net assets showed a slight rise in the second quarter. House price inflation has stabilised at a high level in recent months. Housing starts appear to be moderating.
• Information from Norges Bank's regional network indicates continued growth in demand and production in all industries. With the exception of the construction industry, where activity is already high, growth is expected to be at about the same level over the next six months. There are signs of some skills shortages in construction, manufacturing and some service sectors.
• The former government's budget proposal for 2006 estimates the structural, non-oil deficit for 2006 at NOK 66 billion, which is NOK 2½ billion higher than in 2005. Underlying nominal spending growth is estimated at 3.7 per cent. Local government revenues are estimated to show a nominal rise of 3½ per cent in 2006. The new government has indicated that public spending growth will be higher than proposed by the former government and will be financed by higher direct and indirect taxes.

 Charts - monetary policy meeting (655 Kb)
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 Charts - monetary policy meeting (162 Kb)