The Norwegian economy is still booming and growth remains strong. Consumer price inflation has varied somewhat in recent months, but the overall rate of increase has been approximately as expected. Underlying inflation is estimated at between 1 and 1½ per cent. Cost inflation is rising in line with expectations. Total domestic demand is growing at a brisk pace, with particularly strong growth in household consumption. Employment has increased at a somewhat faster rate than expected, while unemployment is in line with projections.

According to the strategy in Monetary Policy Report 1/07, the key policy rate should lie in the interval 4 - 5 per cent in the period to the publication of the next report on 27 June, conditional on economic developments that are broadly in line with projections. The key policy rate will be increased gradually so that we can assess the effects of interest rate changes and other new information on economic developments.

Outlook and risk factors

In Monetary Policy Report 1/07, CPI inflation was projected to fall markedly in spring and remain low in the period to autumn, primarily reflecting the fall in electricity prices from the high levels prevailing in 2006. As the effect of lower electricity prices unwinds and cost inflation rises, inflation is likely to pick up and near the inflation target of 2½ per cent from next year. Adjusted for tax changes and excluding energy products, inflation is projected to rise gradually to around 2 per cent at the beginning of 2008.

Major shifts in import patterns, weaker global growth, stronger domestic competition, sustained higher productivity growth or a stronger krone exchange rate may result in lower-than-expected inflation. On the other hand, capacity utilisation, output and employment have increased markedly over the past year, which may result in a faster-than-projected increase in prices and costs.

Since the publication of the latest Report, new information shows stronger growth in Europe and China, and despite weaker growth in the US, the risk of a global downturn seems to have diminished. In Norway, growth in demand and employment has been somewhat stronger than expected, but at the same time, the supply of labour has increased to a further extent. Provided that the krone exchange rate does not prove to be considerably stronger than assumed in the Report, domestic and external price developments indicate that the risk of a new and sustained fall in prices for imported consumer goods has diminished. At the same time, the results of this year’s wage negotiations are consistent with projections published in March.

Economic developments

The Executive Board has placed emphasis on the following new information since the previous monetary policy meeting on 25 April:

• Global growth is high. Economic growth in the euro area and China seems to be stronger than expected earlier, while growth in the US has been somewhat weaker than expected. There is still uncertainty surrounding the state of the US housing market.
• The situation in financial markets has remained stable. Equity prices have advanced both in Norway and internationally.
• Oil prices have increased and the Brent Blend spot price has reached USD 71 per barrel. Futures prices for delivery at end-2008 are USD 72 per barrel, approximately unchanged compared with the previous monetary policy meeting.
• The central banks in the UK and New Zealand have increased their official policy rates.
• Interest rate hikes are expected in several other countries through the year. Both short-term and long-term interest rate expectations have increased among our trading partners. In Norway, interest rate expectations have shown a somewhat smaller increase.
• The import-weighted krone exchange rate has appreciated by 0.3 per cent.
• The year-on-year rise in the consumer price index (CPI) was 0.3 per cent in April, down from 1.1 per cent in March. Adjusted for tax changes and excluding energy products, consumer price inflation (CPI-ATE) was 1.4 per cent the past twelve months. The year-on-year rise in inflation measured by a trimmed mean of the rise in the sub-indices in the CPI was 1.2 per cent, while the rise was 1.3 per cent measured by a weighted median.
• In the Revised National Budget for 2007, nominal underlying spending growth is estimated at 7.8 per cent between 2006 and 2007, after rising by 4.4 per cent in the previous year. The non-oil budget deficit is estimated at 2.5 per cent measured as a percentage of mainland GDP. The structural deficit is estimated to increase by NOK 11.7 billion to NOK 67.8 billion, i.e. 3.8 per cent of the capital in the Government Pension Fund – Global. Growth in local government revenues is estimated at 9.5 per cent in 2006 and at close to 4 per cent in 2007.
• According to preliminary quarterly national accounts figures, mainland GDP grew by a seasonally adjusted 1.4 per cent between the fourth quarter of 2006 and the first quarter of 2007. Excluding electricity production, growth was 1.3 per cent in the same period. The figures indicate sustained high growth in consumption, housing investment and exports. Seasonally adjusted, business investment remained virtually unchanged during this period.
• The wage settlement for the central government sector provides a general pay increase of 1.5 per cent. The carry-over into 2007 was 2.9 per cent. The local government wage settlement provides a general pay increase of 1.4 per cent in addition to the 1.4 per cent increase that was awarded in the 2006 settlement. The carry-over into 2007 was 1.7 per cent. Wage drift comes in addition to carry-over and the general increases.
• In April, seasonally adjusted, registered unemployment was 2.0 per cent of the labour force, or unchanged on the March figure. As measured by Statistics Norway’s labour force survey (LFS), seasonally adjusted unemployment was 2.7 per cent of the labour force in March (three-month period February – April), unchanged from February. The number employed increased by 13 000 between December (November – January) to March (February – April).
• According to new orders statistics for the building and construction industry, the value of new orders increased by 15 per cent between the first quarter of 2006 and the first quarter of 2007. The value of total order backlogs rose by 19 per cent in the same period. The value of new manufacturing orders was 31 per cent higher in the first quarter of 2007 than one year earlier. The increase in the value of order backlogs was 47.5 per cent in the same period.
• The manufacturing production index rose by 4.7 per cent between the first quarter of 2006 and the first quarter of 2007. Statistics Norway’s business tendency survey for the first quarter of 2007 shows a continued increase in production volume, order backlogs, employment and capacity utilisation in the manufacturing sector. Enterprises’ debt and liquid assets is still on the rise.
• Prices for traditional goods exports rose by 6.4 per cent between the first quarter of 2006 and the first quarter of this year. Import prices for traditional goods rose by 6.9 per cent in the same period.
• First-quarter income accounts for the household sector show an increase in household real disposable income of a good 5 per cent between the first quarter of 2006 and the first quarter of 2007. In the same period, household nominal wage income increased by a good 9 per cent. TNS Gallup’s trend indicator, which measures households’ assessment of their financial situation and the Norwegian economy, is now at its highest level since the first quarter of 2005. The volume of turnover in the retail industry, excluding motor vehicles and petrol, showed a seasonally adjusted increase of 1.3 per cent between February and March, after rising by 0.2 per cent in the previous month. In 2006, household net borrowing came to NOK 60.9 billion. As a result of substantial gains in securities and foreign exchange markets, household net financial assets nevertheless rose by NOK 31.2 billion. Household domestic debt (C2) increased by 11.9 per cent in the year to March 2007.
• Statistics from the real estate industry show a year-on-year rise in house prices of 16.3 per cent in April 2007, down from a year-on-year rise of 17.4 per cent in March. According to building area statistics, housing starts fell by 2.4 per cent in the first quarter compared with the same period one year earlier. Measured by utility floor space the increase was 4.5 per cent. The year-on-year rise in the cost index for housing construction was 7.6 per cent in April, up from 6.3 per cent in March.
  
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