The objective of monetary policy is low and stable inflation. The inflation target is set at 2½ per cent. The key interest rate is set on the basis of an overall assessment of the inflation outlook, normally two years ahead.

The analyses in Norges Bank's Inflation Report, together with the Bank's current assessment of the outlook for price and cost inflation and developments in the money market and foreign exchange market, provide a basis for decisions concerning the key rate. In the Inflation Report presented today, consumer price inflation two years ahead, with an unchanged interest rate of 6.5 per cent, is projected at 2¾ per cent.

Developments in international financial markets are marked by uncertainty. As in the February Inflation Report, our projections are based on the assumption of a gradual rebound in activity among our trading partners. The upturn is expected to be moderate. Private consumption continued to expand in many countries even during the downturn. As a result, consumption growth is not expected to pick up to the same extent as has been customary during previous cyclical upturns. The oil price has remained firm, also measured in terms of the Norwegian krone.

Growth in the Norwegian economy picked up towards the end of 2001 and into 2002. Private consumption has shown a substantial rise as a result of strong income growth. Households also expect continued strong income growth in the period ahead. Households are still borrowing heavily. Housing investment is high and financial investment is low. House prices are rising. Public expenditure is growing as a percentage of GDP. The level of petroleum investment is expected to be high. Large projects in the aluminium industry are boosting mainland business investment, whereas other investment may be low. There are strong pressures on economic resources. Wage growth is markedly higher than estimated in the February Inflation Report. The results of the various pay settlements point to wage growth of between 5½ per cent and 6 per cent this year. This year's wage settlements resulted in different pay increases for different groups and substantial pay increases that will take effect next year for some groups, even though wage increases are also to be negotiated in 2003. These developments may easily trigger and amplify wage-wage spirals. Persistently high wage growth is contributing to a high rise in prices for domestically produced goods and services.

The year-on-year rise in consumer prices, adjusted for tax changes and excluding energy products, was 2.6 per cent in May.

The Norwegian krone has continued to appreciate. Expectations of higher interest rates as a result of developments in wage settlements have probably contributed to this. Another contributing factor is the weakening of the petroleum fund mechanism as a result of the state's domestic use of NOK 23 billion for the purchase of hospitals. There may also be other factors that have contributed to the appreciation of the krone. Some factors may be of a temporary nature. Developments in the krone exchange rate are discussed further in the Inflation Report.

There is uncertainty as to developments in many of the factors that will influence inflation in the period ahead. This also applies to the krone exchange rate. Relationships in the foreign exchange market are unstable. Our projections for inflation are based on the assumption of a krone exchange rate equal to the average for the second quarter. The krone is now stronger than this. A persistently strong krone will have a dampening impact on inflation compared with the projections we have presented. In the report, we have also illustrated that inflation two years ahead may approach 3 per cent if the krone depreciates.

A further analysis of the inflation outlook and an overview of important features of the Norwegian economy are provided in the accompanying charts.