Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. The monetary policy strategy presented in Inflation Report 1/06 is that the sight deposit rate should lie in the interval 2¼-3¼ per cent in the period to the publication of the next Inflation Report on 29 June 2006, conditional on economic developments that are broadly in line with projections. In line with the strategy, there were prospects of an interest rate increase at the monetary policy meeting in May or June.

The level of activity in the Norwegian economy is high. Employment is rising more rapidly and unemployment has fallen more than projected in the previous Inflation Report. There are now signs of capacity constraints in a number of industries. Wage settlements so far indicate that wage growth will, as expected, be somewhat stronger this year than in 2005. Credit growth is strong and house price inflation is high. There are prospects of a further increase in interest rates among our trading partners.

Underlying inflation is still low, and the krone has appreciated in recent months. The inflation outlook is at the same time being affected by the rise in prices for a number of commodities. The objective of bringing inflation back towards the target and anchoring inflation expectations implies a continued expansionary monetary policy. It is likely that continued high growth in output and employment will result in higher price and cost inflation, although this may take time. The interest rate will therefore be set so that monetary policy gradually becomes less expansionary. The overall assessment implies that the interest rate should be raised at this meeting.

Outlook and risk factors

The analyses in Inflation Report 1/06 were based on a gradual increase in the interest rate towards a more normal level. In the Report, there were prospects that inflation would gradually pick up and be close to the target of 2.5 per cent three years ahead. Capacity utilisation in the economy was projected to increase over the next two years. A further interest rate increase will after a period stabilise growth in output and employment, and capacity utilisation in the economy will decline as a result. This will curb the rise in inflation.

Employment has recently risen more than projected, and unemployment is still falling. At the same time, sickness absence is rising again. The supply of labour from other countries is probably no longer sufficient to compensate for the increase in sickness absence and the number of persons on benefit. Other sources of information confirm the high level of activity in the Norwegian economy. Corporate profitability is solid, and there is a strong increase in the number of new orders in manufacturing and the construction industry. Credit growth is increasing rapidly in the enterprise sector and remains very high among households. The rise in house prices is still high. Equity prices have fallen recently, although this must be seen in the context of strong equity market growth in recent years. So far, there are no indications that financial market turbulence will have substantial, negative effects on domestic or global economic growth.

Underlying inflation measured by the CPI-ATE remains low. At the same time, the krone has shown a noticeable appreciation. Different measures of underlying inflation result in different rates of inflation. The twelve-month rise in these measures varied between 1 and 1¾ per cent in April. While domestic prices have been somewhat lower than expected, prices for imported consumer goods have been slightly higher than expected.

The Inflation Report indicated that continued strong shifts in the import pattern and increased domestic competition may result in lower-than-expected inflation. The Report also highlighted the risk that a long period of low real interest rates might result in more rapid output and employment growth and higher-than-projected price and cost inflation. The balance of risks ahead remains broadly unchanged.

Economic developments

The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting on 26 April:

• The global economy is exhibiting strong growth. GDP in the US expanded briskly again in the first quarter, with strong growth in private consumption. Economic growth in Japan is still strong. Growth has picked up in the euro area, and there are signs of improvement in Germany. The upturn in the Swedish economy is broadly based. Growth remained firm in the UK in the first quarter.
• Developments in energy and commodity prices have pushed up consumer price inflation among several of our trading partners. Core inflation is still moderate, but has recently picked up somewhat in several countries. Equity markets have been marked by turbulence since mid-May.
• Both short-term and long-term interest rates have shown considerable variation recently. Interest rate expectations among our trading partners, which have been rising for a longer period, have now edged down again. Interest rate expectations are still higher than when the Inflation Report was published in mid-March, and in the US and the UK they are also higher than they were at end-April. Since the previous monetary policy meeting, the key rate has been raised by 0.25 percentage point in the US, Canada, Hong Kong and Australia, and by 0.27 percentage point in China. Long-term international interest rates have fallen recently and are lower in the euro area and in Sweden than at the time of the previous monetary policy meeting.
• The price of Brent Blend now stands at USD 69 per barrel, about USD 5 lower than at the time of the previous monetary policy meeting. The price is lower partly because the International Energy Agency (IEA) has revised down its forecasts for growth in global demand for oil in 2006 and because US petrol stocks have increased. Futures prices have fallen somewhat, but are still at more than USD 70 per barrel up to end-2008. Other commodity prices have fallen somewhat since the previous monetary policy meeting, but price levels are still very high.
• The import-weighted krone exchange rate (I-44) is around 1 per cent stronger than at the time of the previous monetary policy meeting and has so far in the second quarter been approximately 3 per cent stronger than the assumptions underlying the analyses in Inflation Report 1/06.
• The year-on-year rise in the CPI-ATE, adjusted for the interest rate's direct effect on house rents and the effects of lower maximum day-care rates, can be estimated at 1.1 per cent in April. The rise in the total consumer price index (CPI) was 2.7 per cent in the year to April.
• The labour market is tightening. According to Statistics Norway's Labour Force Survey (LFS), the number of employed rose sharply in the first four months of this year. Registered unemployment continues to fall. Sickness absence is increasing. Wage settlements so far indicate that wage growth will, as expected, be somewhat stronger this year than in 2005.
• Overall, seasonally adjusted household goods consumption rose in March and April from the level in February. Growth in household credit from domestic sources (C2) edged down in April, although it is still high. House prices showed a sharp increase, recording a year-on-year rise in April of 12.9 per cent. Housing starts picked up again in March.
• The benchmark index on the Oslo Stock Exchange has fallen by 9 per cent since the previous monetary policy meeting. The decline has been most pronounced in commodity-related manufacturing. The benchmark index is nevertheless 14 per cent higher than at the beginning of the year. Statistics Norway's business sentiment survey shows that an increasing share of manufacturing leaders are reporting capacity problems and a shortage of qualified labour. There is a large number of projects on order in both manufacturing and the construction sector. Growth in total gross debt for mainland enterprises showed a further increase in February, and corporate liquidity is increasing substantially.
• In the Government's draft of the Revised National Budget for 2006, the structural non-oil budget deficit, measured as a percentage of trend mainland GDP, is estimated to increase by 0.5 percentage point from 2005 to 2006. Nominal underlying growth in central government expenditure is estimated at 5.3 per cent, which is 0.8 percentage point higher than in the budget approved last autumn. Growth in local government revenues is estimated at 6.1 per cent, adjusted upwards from 5.6 per cent.
• Financial market participants expect a gradual rise in Norges Bank's key rate ahead. Short-term term financial market expectations in Norway have risen somewhat in both the short and the long run since the previous monetary policy meeting. Short-term financial market expectations are slightly higher than the interest rate forecast in Inflation Report 1/06.

 Charts - monetary policy meeting (872 kB)
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 Charts - monetary policy meeting (143 kB)