Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. In Inflation Report 3/05, the assessment of the Executive Board was 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 March 16, conditional on economic developments that are broadly in line with the projections.

The analyses in the Inflation Report implied an increase in the interest rate in the first quarter, at the monetary policy meeting in January or March, and further increases in the interest rate thereafter. New information that has emerged in the period to this monetary policy meeting provides mixed signals. The fall in registered unemployment and the increase in the number of vacancies may indicate that the labour market is tightening more rapidly than assumed. Wage growth remains low, but appears to be rising for some groups of employees. House prices are rising and credit growth continues to increase. On the other hand, consumer price inflation over the past few months has been lower than expected. Inflation can vary considerably from month to month. There is uncertainty with regard to inflation over the coming months because many enterprises change their selling prices at the beginning of the year. Tax increases and lower day-care rates add to the uncertainty surrounding inflation in the first quarter. The high rate of growth in the economy indicates that underlying inflation will gradually pick up, but it is uncertain how rapidly this will occur. The risk factors on each side seem to be somewhat more marked now, but do not as a whole provide grounds for changing the assessment of the outlook.

Outlook and risk factors

The projections in Inflation Report 3/05 were based on a gradual increase in the interest rate towards a more normal level. Inflation as measured by the CPI-ATE was projected to rise gradually and reach the target of 2.5 per cent in 2008. Mainland output is now probably above its normal level. The output gap, which is a measure of capacity utilisation in the economy, is estimated to increase further in 2006. A monetary policy stance that gradually becomes less expansionary will stabilise the economy over time, thereby preventing inflation from overshooting the target.

The Inflation Report pointed to the risk that a low interest rate over a long period may result in strong pressures in the economy, with a risk of bottlenecks, rising cost inflation and debt accumulation. The Report also noted that continued trade shifts and increased competition in labour and product markets might result in lower price and wage inflation and weaker pressures in the economy. The Report highlighted global economic uncertainty, and stated that different developments in global growth and in oil prices might result in a different path for the Norwegian economy than projected.

The labour market may be somewhat tighter than expected. At the moment, total wage growth seems to be broadly in line with the projection. There are, however, some indications that wage growth has picked up for some groups of employees. Equity prices have risen in Norway, and credit growth has accelerated further. These factors may in isolation point to high levels of activity in parts of the economy. At the same time, both imported and domestic inflation have been lower than expected. This has some similarities to the alternative scenario of stronger trade shifts and increased competition. Oil prices have fluctuated since the beginning of November, but are now somewhat higher than assumed in the Inflation Report. There are prospects that the interest rate level will rise among a number of our trading partners and the krone is somewhat weaker than assumed.

Economic developments

The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting on 14 December:

• Economic growth in the US appears to remain solid. According to indicators for the fourth quarter in the US, the picture is still positive for manufacturing. There are signs of somewhat weaker developments in consumption and some signs of a slowdown in the housing market. In the euro area, various confidence indicators reflect increasing optimism in both the corporate and the household sectors. At the same time, growth in private consumption is still weak. In Japan, industrial production has increased, although unemployment has also risen. There has been some improvement in consumer confidence, and retail trade increased slightly in November after falling in the previous months. In the UK, manufacturing developments are still weak, but there are signs that consumption growth is increasing. Activity in Sweden has picked up. Exports and retail trade exhibited solid growth in November. Indicators for December showed high activity in the construction sector and retail trade.
• The year-on-year rise in consumer prices has slowed in the US, the euro area, the UK and Japan. Consumer price inflation is nevertheless still high in the US and slightly above the monetary policy target in the euro area. Inflation has picked up somewhat in Sweden, although it remains low.
• Since our previous monetary policy meeting, the interest rate has been raised by 0.25 percentage point in Sweden, Canada, Switzerland and Hong Kong. Market participants are expecting interest rate increases in the course of the next three months in the US, the euro area, Denmark, Sweden, Canada and Switzerland. In the UK and Australia, the interest rate is expected to remain unchanged in the coming year. Long-term international interest rates have fallen.
• The benchmark index on the Oslo Stock Exchange has risen by 3 per cent since mid-December. Equity prices abroad have varied, but are currently at about the same level as at the time of the previous monetary policy meeting.
• Oil prices have increased by about USD 4 since mid-December and now stand at around USD 63 per barrel. Long-term oil futures have risen somewhat more.
• The import-weighted exchange rate (I-44) has depreciated by just over 1 per cent since the previous monetary policy meeting.
• The year-on-year rise in consumer prices adjusted for tax changes and excluding energy products (CPI-ATE) was 0.9 per cent in December, down from 1.1 per cent in November. Statistics Norway's inflation indicators varied between 0.9 and 1.8 per cent in December. Adjusted for the interest rate's direct effect on house rents, the year-on-year rise in the CPI-ATE is estimated at 1.0 per cent in December. The rise in the total consumer price index (CPI) was 1.8 per cent. Inflation as measured by the CPI-ATE is now 0.4 percentage point lower than projected in the previous Inflation Report.
• Registered unemployment fell more than expected in the fourth quarter. Statistics Norway's LFS unemployment is higher, but has now begun to fall. Employment is showing moderate growth. The number of registered vacancies has increased. After falling sharply through 2004, there are indications that sickness absence is rising slightly again.
• Preliminary figures from Statistics Norway indicate that annual wage growth in retail trade was relatively low in 2005, but somewhat higher than assumed in the Inflation Report. High wage growth has already been recorded in the financial industry and among chartered engineers. Nevertheless, overall wage growth was probably low last year.
• Retail sales picked up in November, but developments in goods consumption have been weaker than expected in recent months. The Confederation of Norwegian Commercial and Service Enterprises reports strong growth in trade at shopping centres in December.
• Twelve-month growth in credit to households from domestic sources (C2) rose to 13.2 per cent in November. In recent months, house price inflation has stabilised at a high level. Housing starts have moderated since summer, but rose somewhat in November.
• Manufacturing production edged up again in the period from September to November after exhibiting a falling trend for some months. Growth in corporate debt moved up in October. Commercial building starts have shown higher growth in recent months. New figures from the Petroleum Directorate indicate that petroleum investment will remain at a high level in the years ahead. The volume of traditional merchandise imports continued to expand from the third to the fourth quarter, while the volume of traditional merchandise exports remained approximately unchanged.
• Financial market participants expect a gradual rise in Norges Bank's key rate ahead. The expected money market rate has fallen in both the short and long term, with long-term rates showing the steepest decline. The decline in interest rates is being ascribed to lower long-term interest rates among our trading partners, the proposed changes in capital adequacy requirements for Norwegian insurance companies and unexpectedly low inflation in December.

 Charts - monetary policy meeting
(Store the file, call it up in PowerPoint, and then double-click on individual charts in order to gain access to the underlying data.)

 Charts - monetary policy meeting