Underlying inflation has been lower than projected in recent months. Nevertheless, several factors point to higher inflation ahead. Capacity utilisation is high and there is little spare capacity in the Norwegian economy. Employment is rising rapidly and unemployment has exhibited a marked decline. There are signs of higher wage growth and expectations of rising inflation. At the same time, the krone exchange rate has depreciated from strong values.

Monetary policy influences the economy with a lag. Over several years, interest rates have been considerably lower than what we consider to be a neutral level. Against the background of high growth in output and employment, rising wage growth and a weaker krone, there are prospects of higher consumer price inflation ahead. The interest rate may gradually be raised to a more normal level at a somewhat faster pace than envisaged earlier, although it is unlikely that rates will be raised at every monetary policy meeting. Based on our current assessment, the interest rate will thus continue to be raised in small, not too frequent steps. According to the monetary policy strategy in Inflation Report 3/06, the sight deposit rate should be in the interval 3¼ - 4¼% in the period to the publication of the next Inflation Report on 15 March, conditional on economic developments that are broadly in line with projections.

Outlook and risk factors

After expanding at a strong pace over several years, the US economy is now showing signs of a slowdown. This may have ripple effects in other countries. It still seems that growth in the world economy will be sustained. The weight of China, India and other Asian economies in the world economy is rising. In the euro area, and to some extent in Japan, the upturn has broadened, and dependence on the US economy has been reduced somewhat.

Mainland GDP growth in Norway will probably be high again in 2007. Capacity utilisation will continue to rise and the labour market will become tighter. High capacity utilisation, rising wage growth and somewhat slower productivity growth are expected to lead to higher inflation, particularly from the second half of 2007 and into 2008. Compared with the previous Inflation Report, inflation is now expected to increase at a somewhat later point in time. Continued moderate growth in labour costs this year, strong competition in product markets, high productivity growth and an increase in the share of imports from low-cost countries will probably contribute to keeping consumer price inflation at a low level to the end of the year and into next year.

New information may reveal aspects of economic developments that indicate that the Norwegian economy is moving on a different path than projected. On the one hand, major shifts in trade patterns, strong competition, weaker global growth or a stronger krone exchange rate may result in low inflation. On the other hand, low real interest rates or a further depreciation of the krone may lead to a higher-than-projected rise in output and inflation.

Economic developments

The Executive Board has placed emphasis on the following new information, which has emerged since the previous monetary policy meeting on 27 September:

• Growth in the world economy remains high, but growth in the US is softening. The fall in energy prices in recent months is restraining the rise in producer and consumer prices. Core inflation in the US increased in August and September, but is still moderate in other countries.
• The policy rate has been raised by 0.25 percentage point in the euro area and Sweden, to 3.25% and 2.75% respectively. After falling through summer, long-term interest rates have increased internationally. Short-term interest rates have also moved up. Market participants expect an interest rate cut in the US in the course of summer 2007. Market interest rates in Norway have increased slightly more than external interest rates.
• After falling sharply in recent months, crude oil prices have shown little change since the previous monetary policy meeting in spite of OPEC's decision to cut production. Oil prices are now about USD 56 per barrel. Oil futures prices in 2008 have increased somewhat, to about USD 67 per barrel. Overall, non-oil commodity prices have also increased.
• Global equity markets have advanced. The benchmark index on the Oslo Stock Exchange has increased by 8 per cent.
• The import-weighted krone exchange rate (I-44) depreciated in the beginning of October, but has appreciated again thereafter. The krone exchange rate is now close to the level prevailing at the previous monetary policy meeting.
• The year-on-year rise in consumer prices (CPI) moved up by 0.7 percentage point to 2.6 per cent from August to September. Consumer price inflation adjusted for tax changes and excluding energy products (CPI-ATE) was 0.5 per cent. Adjusted for the direct effect of interest rates on house rents and the effect of lower maximum day-care rates, the year-on-year rise in the CPI-ATE was 0.8 per cent. In the same period, inflation measured by a weighted median was 1.6 per cent, while it was 1.3 per cent measured by a trimmed mean.
• According to foreign trade statistics for the third quarter, export prices are still rising at a fast pace. The rise in prices for imported intermediate and consumer goods has picked up.
• According to figures from the Norwegian Labour and Welfare Organisation, seasonally adjusted registered unemployment showed a further decline from August to September to 2.4 per cent of the labour force. According to Statistics Norway's labour force survey, seasonally adjusted unemployment was 3.4 per cent of the labour force in the period June-August, i.e. a decline of 13 000 persons on the previous three-month period. In the same period, employment rose by a seasonally adjusted 20 000 persons.
• Growth in total manufacturing production is holding up. According to Statistics Norway's business tendency survey for the third quarter, capacity utilisation in the manufacturing sector is high and production is expected to show further growth in the final quarter of this year. Building activity is still buoyant. Mainland enterprises are steadily accumulating more debt. The twelve-month rate of growth in their domestic debt (C2) has increased, and stood at 21.7 per cent in September. Money growth in the enterprise sector is still rising at a fast rate.
• Household spending on goods rose in August and September. According to the real estate industry's house price statistics, the year-on-year rise in house prices was 17.8 per cent in September. Statistics Norway's house price index for the third quarter showed a rise of 14.5 per cent on the same quarter one year earlier. High debt growth and lower investment in financial assets have contributed to a fall in household net lending over the four quarters to the second quarter of 2006. The rate of household debt accumulation was also high in the third quarter.
• Local government finances have improved, primarily as a result of strong growth in tax revenues. In the four quarters to the second quarter of 2006, local government net lending is estimated at NOK 3bn.
• In the Government's budget proposal for 2007, the structural, non-oil deficit for 2007 is estimated at NOK 71bn, i.e. an increase of NOK 8.2bn on 2006. Petroleum revenue spending is estimated at about 4.0 per cent of the capital in the Government Pension Fund - Global. Underlying nominal growth in government spending is estimated at 6.4 per cent. Strong growth in the Norwegian economy is boosting tax revenues and reducing spending on unemployment benefits. As a result, the general government budget deficit excluding transfers from the Government Pension Fund - Global will be reduced from 2006 to 2007. These automatic stabilisers are also dampening cyclical fluctuations.

Charts - monetary policy meeting (126 kB)
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Charts - monetary policy meeting (792 kB)