Prices for many goods and services have increased at a faster pace in recent months. Underlying inflation has for some time been projected at between 1½ and 2 per cent in the latter half of this year. Various measures of underlying inflation have so far increased broadly in line with projections. Prices for domestically produced goods and services have in particular risen at a fast pace. Growth in the economy has been stronger than expected. Cost inflation is on the rise and there are prospects of a further pick-up in price inflation. These conditions suggest that the interest rate should be increased.

On the other hand, financial markets have been turbulent since the beginning of August and the global economic outlook is uncertain. The krone is strong. Given the inflation target, we will be mindful of the effects of higher interest rates on the krone exchange rate when inflation is low. The Executive Board considered the alternative of leaving the key policy rate unchanged at today’s meeting.

According to the strategy in Monetary Policy Report 2/07, the key policy rate should be in the interval 4½ - 5½ per cent in the period to the publication of the next Report on 31 October, conditional on economic developments that are broadly in line with projections. The interest rate will be increased gradually so that we can assess the effects of interest rate changes and other new information on economic developments. If the turmoil in financial markets persists and the krone remains strong, and this has considerable consequences for the outlook for inflation, output and employment, Norges Bank’s key policy rate may be raised to a lesser extent than envisaged in June.

Outlook and risk factors
In Monetary Policy Report 2/07, inflation measured by the CPI was projected to pick up markedly next year from a very low level this year. Inflation adjusted for tax changes and excluding energy products (CPI-ATE) was projected to pick up more gradually. Capacity utilisation is currently at such a high level that inflation is projected to gradually move up to 2.5 per cent. At the same time, the increase in interest rates will lead to a gradual fall in capacity utilisation so that inflation does not become too high.

New information may reveal aspects of economic developments that indicate that the Norwegian economy is moving on a different path than projected. In Monetary Policy Report 2/07, it was pointed out that high capacity utilisation and higher cost inflation may on the one hand lead to higher-than-projected inflation. Sustained high productivity growth, a more pronounced shift towards imports from low-cost countries and a stronger krone exchange rate may on the other hand result in lower-than-expected inflation.

Cost inflation is now on the rise as a result of higher wage growth. Moreover, productivity growth in the business sector seems to be easing. The rise in prices for imported goods, which tend to show monthly variations, has been somewhat lower than expected and the krone is now strong.

Growth in household consumption, investment, employment and the supply of labour has been stronger than projected. At the same time, there are as expected signs of slower growth in the housing market and some segments of the construction sector. Our regional network confirms the picture of sustained solid growth in the Norwegian economy, but there are signs that the pace of growth may soften ahead as a result of capacity constraints.
The turbulence in financial markets may imply weaker developments both in the US and Europe. The financial sector in several countries has been affected.

Economic developments
The Executive Board has placed emphasis on the following new information since the previous monetary policy meeting on 15 August:

• Losses linked to defaults on US subprime mortgage loans have led to an increase in risk premia in credit and bond markets. There are fears of losses at banks and finance companies in both the US and Europe. Banks have become more reluctant to extend loans to one another. Extraordinary injections of central bank liquidity have contributed to keeping the shortest money market rates at normal levels, but only for terms of less than one week. The risk associated with interbank lending now seems to be perceived as higher, and money market rates with longer maturities have increased in the US, the euro area, the UK and Sweden. Norwegian money market rates with slightly longer maturities have also risen. 
• Global growth prospects have weakened as a result of the turmoil in financial markets. The US labour market has weakened. There are prospects of lower growth in the US and Europe. Economic growth in emerging economies remains strong, particularly in China.
• The central banks in Sweden and Switzerland have raised their official interest rates by 0.25 percentage point, and the central bank in China has raised its key rate by 0.27 percentage point. The Federal Reserve has cut its key rate by 0.50 percentage point. Interest rate expectations have decreased abroad and at home.
• Equity prices have fluctuated, but are on the whole somewhat higher than in mid-August.
• Oil prices have increased in US dollar terms. The spot price of Brent Blend oil is now about USD 78 per barrel. Norwegian petroleum production declined by about 5 per cent in the period January-July this year compared with the same period one year earlier.
• The import-weighted krone exchange rate has appreciated by about 2.8 per cent since the previous monetary policy meeting and by about 3.4 per cent since the publication of Monetary Policy Report 2/07.
• The year-on-year rise in the consumer price index (CPI) was 0.4 per cent in August, unchanged on June and July. Adjusted for tax changes and excluding energy products, the rate of increase in consumer prices (CPI-ATE) was 1.8 per cent over the past twelve months, up from 1.4 per cent in July. The rise in prices measured by a trimmed mean of the rise in the sub-indices in the CPI was 1.5 per cent in August, while a weighted median showed a rise of 1.6 per cent.
• According to preliminary quarterly national accounts figures, GDP for mainland Norway increased by a seasonally adjusted 1.3 per cent between first and second quarter. Excluding electricity production, growth was 1.0 per cent. First-quarter growth was revised up by 0.2 percentage point to 1.6 per cent and to 1.5 per cent excluding electricity production.
• According to preliminary figures from Statistics Norway’s wage index for the second quarter of this year, average growth in monthly wages was 5.8 per cent from the second quarter of 2006 to the second quarter of this year.
• In August, seasonally adjusted registered unemployment stood at 1.8 per cent of the labour force, 0.1 percentage point lower than in July. As measured by Statistics Norway’s labour force survey (LFS), seasonally adjusted unemployment was 2.5 per cent in June (three-month period May-July). Employment increased by 5 000 between May and June, while the labour force expanded by 4 000 in the same period.
• Manufacturing production increased by a seasonally adjusted 0.9 per cent in the period May-July compared with the previous three-month period. In the investment intentions survey for the third quarter of this year, manufacturing investment for this year was estimated at NOK 27.7 billion at current prices. Compared with the estimates for 2006, the survey indicates growth of 30 per cent this year. The value of new orders in manufacturing was 18 per cent higher in the second quarter of this year than in the same period one year earlier. The same comparison for the stock of orders shows an increase of 44 per cent.
• According to investment intentions survey for oil and gas production, including pipeline transport, total investment for 2007 is estimated at NOK 117.5 billion at current prices. This implies value growth of 23 per cent between 2006 and 2007. Investment for 2008 is now estimated at NOK 119.2 billion, which is the highest estimate published since the survey started in 1985.
•  According to order statistics for the construction industry, the value of new orders increased by 20 per cent between the second quarter of 2006 and the second quarter of 2007. The value of the total stock of orders increased by 21.0 per cent in the same period.
• Norges Bank’s regional network reports continued solid growth in all industries, but growth seems to be somewhat lower than in spring. Market prospects for the coming six months indicate sustained solid growth. Several industries report that capacity constraints have limited growth and will continue to limit growth potential ahead. Estimates for annual wage growth this year have been adjusted upwards for all industries. Prices have risen at a brisk pace over the past twelve months, particularly in the construction industry and commercial services, and the rise in prices is the highest registered in the network. Fewer enterprises now expect prices to rise at a faster pace ahead. Profits are rising in all industries, but at a slower pace than earlier this year.
• Gross domestic debt of enterprises was 20.5 per cent higher in July than at the same time last year. The corresponding increase in the money supply was 26.1 per cent in the same period. Rental prices for Oslo’s most attractive commercial premises rose by almost 30 per cent in the first six months of the year. Commercial property starts in square metres rose by 18.4 per cent in the first seven months of this year compared with the same period one year earlier. 
• Twelve-month growth in household gross domestic debt was 12.3 per cent at the end of July, up from 12.0 per cent at end-June. TNS Gallup’s expectations survey, which measures households’ assessments and expectations concerning their financial situation and the Norwegian economy, showed a trend-adjusted decline between the second and third quarter. This is the second consecutive quarter of decline and the level is now on a par with that recorded in the third quarter of last year. Household spending on goods was 7.8 per cent higher in July than the same month one year earlier.
• House price statistics from the real estate industry show that the seasonally adjusted monthly rise in house prices slowed for the second consecutive month in August. The twelve-month rise was 9.2 per cent in August, down from 11.7 per cent in July. In the first seven months of the year, housing starts rose by 3.2 per cent compared with the same period one year earlier. Measured by utility floor space, the increase was 6.6 per cent in the same period. 

Charts and background material