Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. According to the monetary policy strategy in Inflation Report 2/06, the sight deposit rate should be in the interval 2¾ - 3¾ per cent in the period to the publication of the next Inflation Report on 1 November, conditional on economic developments that are broadly in line with projections.

Capacity constraints and a shortage of skilled labour are posing a mounting challenge to a number of enterprises. At the same time, corporate earnings are very high. Local government tax revenues have increased substantially. Household and corporate borrowing remains high. Property prices are rising markedly, and the level of building activity is high. Growth among our trading partners is solid, and a number of countries have raised their policy rates. These factors point to a higher interest rate. At the same time, underlying consumer price inflation remains low. Clothing and footwear prices fell to a surprising extent in July. Different indicators of underlying inflation range from just under 1 per cent to almost 1¾ per cent, and energy prices are rising sharply. The krone exchange rate has depreciated somewhat recently, but is still fairly strong.

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 a gradual pick-up in inflation. The interest rate will therefore be set so that monetary policy gradually becomes less expansionary. The strategy published in the Inflation Report coupled with new information implies that the interest rate should be raised at the present meeting.

Outlook and risk factors

The analyses in Inflation Report 2/06 were based on a gradual increase in the interest rate towards a more normal level. In the first six months of 2006, the key rate was increased twice by increments of 0.25 percentage point. There are prospects that the interest rate will rise further at about the same pace. In the Inflation Report, capacity utilisation is projected to increase this year and in 2007. This will contribute to a gradual pick-up in inflation, bringing it close to the target of 2.5 per cent three years ahead. A gradual increase in the interest rate will curb growth in demand for goods and services and the rise in credit and house prices.

The Inflation Report indicated that continued pronounced shifts in the import pattern, a strong krone exchange rate and keen domestic competition may result in lower-than-expected inflation. The Report also highlighted the risk that a long period of low real interest rates may result in more rapid output and employment growth and higher-than-projected price and cost inflation. High oil prices may have a stronger impact on consumer prices than seen so far. Moreover, stronger price impulses from our trading partners may translate into higher-than-expected imported price inflation. Overall, developments since the previous monetary policy meeting do not provide grounds for changing the outlook for inflation and output or the risk assessment.

Economic developments

The Executive Board has placed emphasis on the following new information, which has emerged since the previous monetary policy meeting on 29 June:

• Economic growth in Sweden, the UK and the euro area is high. Economic developments in China and India remain strong. GDP growth in the US and Japan has slowed.
• Consumer price inflation among a number of our trading partners is high as a result of rising energy prices, but the increase in prices for other goods and services remains moderate. Commodity prices have been volatile, but overall they have risen somewhat since the end of June. International equity markets have stabilised since the turbulence in May, and have edged up since the previous monetary policy meeting.
• Since the previous monetary policy meeting, the key rate has been raised by 0.25 percentage point in the US, the euro area, Denmark, the UK, Japan and Australia. In the US, there are now expectations that the interest rate has peaked, and that it will be lowered towards the end of 2007. A rise in key rates is expected over the next year in the euro area, Sweden, the UK, Australia, Japan and Switzerland. Interest rates among some trading partners have shown fairly wide variations. Overall, short-term interest rates among trading partners have been broadly unchanged, while long-term rates have edged down since the previous monetary policy meeting. The fall in interest rates has been most pronounced in the US.
• Crude oil prices rose during the summer, partly as a result of the conflict in the Middle East and reduced production in Nigeria and the US. The price of North Sea Brent Blend has fallen slightly in the last few days to around USD 74 per barrel, or about USD 2 higher than at the time of the previous monetary policy meeting. Futures prices have also risen, and are now between USD 74 and USD 77 per barrel up to end-2008. Market prices for electricity increased considerably this summer, and futures prices point to continued high electricity prices ahead.
• The import-weighted krone exchange rate (I-44) is around 1¾ per cent weaker than at the time of the previous monetary policy meeting.
• The year-on-year rise in the CPI-ATE was 0.6 per cent in July, down from 0.8 per cent in June. Adjusted for the direct effect of the interest rate on house rents and the effects of lower maximum day-care rates, inflation can be estimated at 0.9 per cent in July and 1.1 per cent in June. The trimmed mean and weighted median showed a rate of increase of 1.5 per cent and 1.7 per cent, respectively, in July. The total consumer price index (CPI) rose 2.2 per cent in the year to July, compared with 2.1 per cent in June.
• According to Statistics Norway's Labour Force Survey, unemployment fell further in May. Employment has continued to rise, while the labour force has declined somewhat. Registered unemployment also fell in July, and now stands at a seasonally adjusted 2.6 per cent of the labour force. The number of work permits issued by the Norwegian Directorate of Immigration is still rising.
• Seasonally adjusted household goods consumption fell from May to June, following a strong rise in May. House prices increased further this summer, and the twelve-month rise moved up to 15.8 per cent in July. Residential construction is still high. Growth in household debt (C2) has abated somewhat in recent months, but remains at a high level.
• The Oslo Stock Exchange benchmark index has risen by 1½ per cent since the previous monetary policy meeting, and is now 13 per cent higher than at the beginning of the year. Growth in total gross debt of mainland enterprises continues to rise. Listed companies posted very high operating results in the first half of 2006.
• Statistics Norway's business tendency survey for the second quarter is still giving positive signals regarding developments in Norwegian manufacturing. Capacity constraints and a shortage of skilled labour are posing a mounting challenge in some manufacturing sectors. A clear majority of industrial leaders assess the general outlook for the third quarter as more positive than for the second quarter.
• Tax statistics from Statistics Norway show that non-oil central government tax revenues were 10.4 per cent higher in the first half of 2006 than in the same period last year. Local government tax revenues rose by 9.9 per cent.
• Financial market participants expect a gradual rise in Norges Bank's key rate ahead. Interest rate expectations have been lowered somewhat in the medium term, albeit less than among trading partners.

 Charts - monetary policy meeting
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 Charts - monetary policy meeting