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 baseline scenario in the Inflation Report published on 30 October was based on the assumption of a krone exchange rate equal to the average for the previous three months. Inflation at the end of 2004 was projected at 2½ per cent. In the same report, analyses based on alternative exchange rate assumptions showed that with a 3 per cent appreciation of the krone, inflation two years ahead would fall to 2¼ per cent.

Since the publication of the Inflation Report, the krone has appreciated and is 3 per cent stronger than assumed in the baseline scenario. The strong krone is related to a considerably higher interest rate in Norway than in most other countries. This in turn is due to the relatively high level of wage and cost inflation in Norway, which reflects Norway's divergence from international cyclical developments. Fears of war in Iraq and high oil prices may have increased the flow of short-term capital into Norway and contributed to the appreciation of the krone.

Fear of war, low production in Iraq and the loss of production in Venezuela have contributed to an increase in the price of oil to over USD 30 per barrel. Oil stocks in the US and other OECD countries are now low. Capacity utilisation in Saudi Arabia's oil production is fairly high. In the short term, this will keep the oil price at a high level, but developments may also lay the basis for a subsequent fall and wide fluctuations in the oil price.

The recovery in the international economy is sluggish and uneven. Very low interest rates and tax cuts in the US and other countries are stimulating activity. It is still uncertain when global growth will pick up and become self-driven. The effects of the sharp fall in equity prices and earlier over-investment in several sectors have probably not yet been exhausted.

Consumer price inflation rose markedly from November to December. This reflects higher electricity prices. Adjusted for tax changes and excluding energy products, the year-on-year rise in consumer prices was 1.8 per cent in December 2002. This was broadly in line with expectations. The increase in the price of electricity will lead to a sharp rise in the consumer price index over the next few months, but this is a short-term effect that does not directly influence the interest rate.

Household borrowing is still high and the household debt burden continues to rise. Although growth in credit to households slowed somewhat from November 2001 to November 2002, double digit growth continues. The rise in house prices now appears to be slowing. Developments in the housing market and reduced optimism in the household sector may result in slower credit growth in the future.

Developments in the retail sales index up to November last year indicate solid growth in private consumption. The increase in the price of electricity will reduce growth in household real disposable income this year. Growth in private consumption this year may therefore be lower than projected in the October Inflation Report. Higher electricity expenses for enterprises and households will largely be offset by higher income for other Norwegian sectors, and will therefore probably only have a limited impact on domestic demand in the next two to three years.

Labour market developments have been broadly in line with expectations since the previous Inflation Report. We have not yet seen the full effect of high wage growth and the strong krone on employment in enterprises that are particularly exposed to international competition.

Overall, these trends point to somewhat lower price inflation ahead. According to Norges Bank's assessment, with an interest rate of 6.0 per cent, the probability that inflation two years ahead will be lower than 2½ per cent is greater than the probability that it will be higher.

Charts used in connection with the Executive Board's monetary policy meeting:

The global economy (203 kB)

Financial markets (299 kB)

Demand and production (72 kB)

The labour market (72 kB)

Prices (76 kB)