The objective of monetary policy is low and stable inflation. The inflation target is set at 2.5 per cent. Monetary policy affects the economy with considerable and variable lags, and the Bank must thus be forward-looking in its interest-rate setting. The key rate is set on the basis of the inflation outlook, normally for a few years ahead.

Changes in the interest rate will be made gradually so that the Bank may assess the effects of interest rate changes and other new information on economic developments. If the inflation outlook deviates substantially from the target for a period, Norges Bank will set the interest rate with a view to gradually returning consumer price inflation to the target. The use of instruments may be more extensive if the economy and the inflation outlook are exposed to considerable disturbances stemming for example from developments in the international economy or the oil market. A more extensive use of instruments could also prove to be appropriate if for example heightening turbulence in financial markets or a cost-push shock resulting from negotiations indicate that confidence in monetary policy is in jeopardy. Norges Bank will seek to clarify its response pattern. With a credible inflation target, Norges Bank may achieve nominal stability with less fluctuation in the real economy.

The analyses in Norges Bank's Inflation Report, together with its current assessment of the inflation outlook and developments in the money market and foreign exchange market, provide the basis for decisions concerning monetary policy instruments. Norges Bank's assessment of the outlook for economic developments was last presented in the Inflation Report published on March 8. Price inflation was projected at 2 per cent in 2003 based on the assumption of unchanged interest rates. However, the projections for economic developments must be assessed in the light of the new guidelines for economic policy of 29 March (see Norges Bank's press release of 29 March). The new inflation target may influence the projections through inflation expectations. The phasing in of petroleum revenues from 2002 as described in the Government's Long-Term Programme will also have an effect. The inflation projections presented in the March Inflation Report were based on the technical assumption of a neutral fiscal stance.

Global economic growth is slowing and there is substantial uncertainty associated with developments ahead. The Federal Reserve has reduced the target for the federal funds rate by a total of 2.5 percentage points since the beginning of the year. Interest rate cuts have also been made in a number of other countries.

The Norwegian economy is marked by high capacity utilisation. The labour market is very tight. This increases the risk of higher-than-projected cost inflation. House prices have risen at a faster pace than expected. The credit supply remains high. The year-on-year rise in the consumer price index was 3.8 per cent in April. Excluding changes in indirect taxes and electricity and petrol prices, price inflation was about 2½ per cent. Measured by the import-weighted krone exchange rate index, the krone appreciated by 1.8 per cent in relation to that assumed in the March Inflation Report. In isolation, this will have a dampening impact on external price impulses.

On balance, domestic developments suggest a tighter monetary policy stance. On the other hand, international developments with the possibility of a pronounced and prolonged downturn may lead to lower-than-expected inflation. In the light of recent trends in the economy and the current balance of risks, the probability that the next change in the interest rate will be a reduction is the same as the probability of an increase.