Consumer price inflation remains moderate in spite of a prolonged cyclical upturn in the Norwegian economy. Underlying inflation has been relatively stable and ranged between 1 per cent and 1½ per cent for some time. There are nevertheless several factors indicating that inflation will pick up. Wage growth is rising and there are prospects that the economic expansion will last somewhat longer than previously envisaged. Employment is rising approximately as projected and unemployment is lower than during the previous expansion. There is a shortage of labour and certain important input factors in many industries. Temporarily low CPI inflation this year will be followed by temporarily high CPI inflation next year. Excluding energy prices, inflation is projected to rise at a more gradual pace, but the projections are uncertain.

The interest rate path presented in Monetary Policy Report 2/07 reflects the Executive Board’s trade-off between bringing inflation up towards target and stabilising developments in output and employment. In the light of this trade-off, 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. 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 key policy rate was most recently raised in May. 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 Executive Board has concluded that it is appropriate to increase the key policy rate by 0.25 percentage point to 4.50 per cent at today’s meeting.

Outlook and risk factors
Inflation measured by the CPI is projected to pick up markedly next year from a very low level this year. Electricity prices have declined from high levels in 2006 and contributed to a marked fall in CPI inflation. As a result of the prospect of high electricity prices early next year, CPI inflation may exceed 3 per cent in early 2008. The rise in the CPI adjusted for tax changes and excluding energy products (CPI-ATE) is expected to pick up to around 2 per cent in the latter half of 2008.

Capacity utilisation is currently at such a high level that inflation will gradually move up to 2.5 per cent. At the same time, the increase in interest rates may lead to a gradual fall in capacity utilisation so that inflation does not become too high.

Growth in the global economy remains robust. Inflation has edged up in some countries. Interest rate expectations abroad have increased markedly in recent months. The general rise in prices in the world economy has been low, but high commodity prices and lower resource availability engenders a risk of rising inflation.

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, high capacity utilisation or higher cost inflation may lead to higher-than-projected inflation. On the other hand, sustained high productivity growth, a more pronounced shift towards imports from low-cost countries and a stronger krone exchange rate may result in lower-than-expected inflation.

Economic developments

The Executive Board has placed emphasis on the following new information since the previous monetary policy meeting on 30 May:

• Interest rate expectations abroad have increased markedly in recent months. Growth in the global economy remains robust. Central banks in the euro area, Denmark, New Zealand, Sweden and Switzerland have raised their official interest rates. The tightening cycle might last somewhat longer in European countries than assumed earlier. Official interest rates in the US are no longer expected to be lowered. Interest rate expectations in Norway have also increased.
• Equity prices internationally and in Norway are approximately at the same level as around the previous monetary policy meeting. Long-term interest rates have increased markedly. The increase can be seen in connection with the abnormally low levels that prevailed for some time.
• Oil prices have increased somewhat. Futures prices at end-2008 are also somewhat higher than around the previous monetary policy meeting.
• The import-weighted krone exchange rate has appreciated by about 1¼ per cent.
• The year-on-year rise in the consumer price index (CPI) was 0.3 per cent in May, unchanged from April. Adjusted for tax changes and excluding energy products, consumer price inflation (CPI-ATE) was 1.4 per cent in May. The twelve-month rise measured by both a trimmed mean of the rise in the sub-indices in the CPI and measured by a weighted median was 1.2 per cent in May.
• In May, seasonally adjusted registered unemployment was 1.9 per cent of the labour force, down by 0.1 percentage point on the previous month. AS measured by Statistics Norway’s labour force survey (LFS), seasonally adjusted unemployment was 2.7 per cent in March (three-month period February-April). In the same period, employment was unchanged, but the labour force grew by 1 000. 
• The manufacturing production index rose by 6.1 per cent in the year to April 2007.
• Statistics Norway’s investment intentions survey for manufacturing and the power industry indicates continued solid investment growth this year. In the investment intentions survey for oil and gas production, including pipeline transport, the estimate for total investment in 2007 was revised up in relation to the first-quarter survey. Corporate borrowing is still rising rapidly and the volume of enterprises’ liquid assets is high.
• Information from Norges Bank’s regional network shows that enterprises expect continued solid growth in production, but expect growth to be slightly lower than the level recorded so far. Many enterprises report that a shortage of labour and certain important input factors are limiting growth in production. Investment will increase, but at a slower rate than earlier. Selling prices are rising rapidly for products for businesses, but the rise is more moderate for consumer goods.
• Household spending on goods fell by a seasonally adjusted rate of 1.1 per cent from March to April, after rising by 0.8 per cent the previous month.
• Statistics from the real estate industry show that house prices rose by 14.4 per cent in the year to May 2007, down from 16.3 per cent in April. House price statistics from the Oslo Housing and Savings Society showed an easing of the twelve-month rise from April to May. Household debt accumulation remains high.
• According to building statistics, housing starts rose by 4.3 per cent from January to April 2007 compared with the same period one year earlier. In the first four months of the year, commercial building starts measured in square metres were 15.2 per cent higher than in the same period last year.  

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