There is now little slack in the Norwegian economy. A steadily rising share of enterprises lack the capacity to accommodate increased demand, largely because of labour shortages. The labour market has grown considerably tighter, and there are several signs that wage growth is picking up. Developments in aggregate demand, output and employment suggest a higher interest rate.

At the same time, the rise in consumer prices is slowing, and the rise in prices excluding energy products is unexpectedly low. This suggests a continued low interest rate.

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. Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. The strategy published in the Inflation Report, coupled with new information, implies that the interest rate should be kept unchanged at the present meeting.

Continued high capacity utilisation and growth are likely to result in a gradual pick-up in inflation. The interest rate will therefore be set so that monetary policy gradually becomes less expansionary.

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 in two increments of 0.25 percentage point. There were prospects that the interest rate would rise further at about the same pace. In Inflation Report 2/06, inflation is projected to pick up gradually, bringing it close to the target of 2.5 per cent three years ahead. The gradual increase in the interest rate will curb growth in demand for goods and services, credit growth and house price inflation.

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 pointed out 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.

New information since the Inflation Report was published provides mixed signals. The rise in prices has slowed. CPI inflation is approximately as expected, but it is lower than projected when excluding energy products. Strong competition and high productivity growth, coupled with fairly low wage growth, have contributed for a long period to holding down the rise in prices for Norwegian goods and services. New data indicate that pressures in the Norwegian economy are now building up more rapidly than expected. At the same time, the krone has depreciated from high values.

Economic developments

The Executive Board has placed emphasis on the following new information, which has emerged since the previous monetary policy meeting on 16 August:

• Growth in the Norwegian economy is high. Preliminary national accounts figures show that mainland GDP was 3.8 per cent higher in the first half of 2006 than in the first half of 2005. Growth was primarily fuelled by exports and private consumption.
• Employment is rising sharply. According to national accounts figures, the number of employed and the number of person-hours worked increased by 2.2 per cent and 1.8 per cent, respectively, from the first half of last year to the first half of 2006. According to Statistics Norway's Labour Force Survey (LFS), the seasonally adjusted number employed was 17 000 higher in the period May-July than in the previous three-month period.
• Unemployment has fallen markedly. According to the LFS, seasonally adjusted unemployment was 3.2 per cent in the period from May to July, a decline of 0.3 per cent on the previous three-month period. Registered unemployment fell further in August, and now stands at a seasonally adjusted 2.5 per cent of the labour force.
• Capacity utilisation in the business sector is high. The share of enterprises in Norges Bank's regional network reporting problems in accommodating demand has increased to 59 per cent. The primary capacity constraint is labour. Enterprises' estimates of this year's wage growth have been revised upwards somewhat, and there are reports of continued solid growth and positive prospects for the next six months. In manufacturing and the construction sector, order stocks are substantial and new orders and production are still on the rise. Building activity remains at a high level. The oil and gas sector has revised up its investment plans for 2007, largely as a result of increased exploration activity.
• Growth in corporate debt is picking up. In July, corporate debt to domestic creditors was 19.7 per cent higher than in July 2005. At the same time, corporate liquidity has increased substantially.
• Growth in household debt edged down in July, but is still high. Growth in consumption remains buoyant. Household goods consumption rose by 2.2 per cent from July 2005 to July 2006. House prices rose on a seasonally adjusted basis by 1.7 per cent from July to August, and are now 17.7 per cent higher than at the same time in 2005. TNS Gallup's trend indicator shows that households remain optimistic in their view of the domestic economy and their own financial situation.
• The twelve-month rise in the CPI slowed from 2.2 per cent in July to 1.9 per cent in August. Both imported and domestic inflation have been lower than expected. Consumer price inflation adjusted for tax changes and excluding energy products (CPI-ATE) was 0.4 per cent. If an adjustment is also made 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 0.7 per cent, a decline from 0.9 per cent in July. Other measures of underlying inflation, such as the trimmed mean and the weighted median, rose by 1.3 per cent and 2.1 per cent, respectively, in August.
• According to TNS Gallup's expectations survey for the third quarter, expectations regarding the general rise in prices two years and five years ahead have increased somewhat. Expectations regarding wage growth in 2006 and 2007 are also higher than earlier. Long-term inflation expectations are still close to the inflation target. More business leaders than previously expect a faster rise in their selling prices in the coming year.
• Energy prices are exerting upward pressure on global inflation. Core inflation is still moderate in most countries, but has risen to 2.8 per cent in the US.
• Overall, growth among our trading partners has been higher than expected. Economic growth in Sweden, the UK and the euro area is high. In the US and Japan there are signs of slower growth. On balance, equity markets worldwide have shown little change. The benchmark index on the Oslo Stock Exchange has fallen by approximately 6 per cent since the previous monetary policy meeting.
• Crude oil prices have fallen by 21 per cent since the last monetary policy meeting, to about USD 57 per barrel. Futures prices have fallen less, to USD 66 per barrel at end-2008. Prices for non-oil commodities have edged down.
• Since the previous monetary policy meeting, the key rate has been raised by 0.25 percentage point in Sweden and Switzerland. Iceland's policy rate has been raised by 0.5 percentage point. Market participants expect that the tightening cycle will be concluded among most of our trading partners in the first half of 2007. For the US and Canada, market participants have priced in interest rate cuts of 0.5 percentage point over the next year.
• There has been a global decline in long-term interest rates. Interest rate expectations have also declined in Norway, but less than among trading partners.
• The import-weighted krone exchange rate (I-44) has depreciated by about 3½ per cent since the previous monetary policy meeting. So far in the third quarter, the krone exchange rate has been about 3 per cent weaker than projected in the June Inflation Report.

Charts - monetary policy meeting (829 kB)
(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 (150 kB)