Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. The monetary policy strategy presented in Inflation Report 1/06 is that the sight deposit rate should lie in the interval 2¼-3¼ per cent in the period to the publication of the next Inflation Report on 29 June 2006, conditional on economic developments that are broadly in line with projections.
The underlying rise in consumer prices was approximately as expected in February and March, although the year-on-year rise is still low. The objective of bringing inflation back towards the target and anchoring inflation expectations implies a continued expansionary monetary policy. Output growth is high, and employment is rising more rapidly than expected. It is likely that continued high growth in output and employment will result in higher price and cost inflation, although this may take time. The interest rate will therefore be set so that monetary policy gradually becomes less expansionary.
The interest rate was last raised in March. In line with the forecast in the March Inflation Report, there are prospects of another interest rate increase in the second quarter - at the monetary policy meeting in May or June - and a further increase thereafter.
Outlook and risk factors
The analyses in Inflation Report 1/06 were based on a gradual increase in the interest rate towards a more normal level. Core inflation was projected to increase to close to 2 per cent at the end of 2007 and be near the target of 2.5 per cent at the three-year horizon. Capacity utilisation in the economy was expected to rise over the next two years. A further interest rate increase will gradually stabilise growth in output and employment, and capacity utilisation in the economy may decline somewhat. This will curb the rise in inflation.
The Inflation Report indicated that continued strong shifts in the import pattern may result in a further fall in prices for imported goods included in the consumer price index. Increased competition may also lead to low inflation. The Report also stated that it is uncertain how quickly price and wage inflation will accelerate when growth in output and employment picks up.
Employment is now rising more rapidly than expected. Corporate earnings are rising and growth in corporate demand for credit has moved up. The sharp increase in household debt is persisting. House price inflation remains high. Prices for oil and several other commodities have picked up further. At the same time, the underlying rise in consumer prices is still low. So far, a tighter labour market does not seem to have resulted in higher-than-expected negotiated pay increases, but there is a risk that wage inflation may subsequently pick up more than expected. The krone is stronger than assumed. Overall, there are not sufficient grounds for changing the outlook for inflation and output or the assessment of risk factors.
The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting:
- Economic growth in the US probably picked up again in the first quarter. In Japan, growth appears to be solid. In the euro area, confidence indicators point to optimism in the business sector. There is a broad-based expansion in the Swedish economy, while some indicators in the UK have shown weak developments. Equity prices abroad are higher than at the time of the previous monetary policy meeting on 16 March.
- High commodity prices are exerting upward pressure on consumer price inflation in a number of countries, although underlying inflation remains low.
- The central banks in the US, Canada and Switzerland have raised their key rates by 0.25 percentage points. Market expectations concerning key rates in other countries have risen slightly. For the year ahead, market pricing indicates that key rates will be increased in the euro area, the UK, Sweden, Switzerland, the US, Canada, Japan and Australia. The rise in global long-term interest rates has gained momentum.
- Oil prices have risen to over USD 74 per barrel, partly as a result of the uncertain political situation in a number of producer countries. Futures prices for Brent Blend are now more than USD 72 per barrel up to autumn 2008. Oil futures 6-7 years ahead have also risen, to approximately USD 69 per barrel. Metals prices have increased markedly. Over the past year, cobber prices have almost doubled and aluminium prices have risen by approximately 50 per cent.
- Measured by the import-weighted exchange rate index (I-44), the krone is about 2 per cent stronger than at the time of the previous monetary policy meeting.
- The year-on-year rise in the CPI-ATE, adjusted for the interest rate's direct effect on house rents and the effects of lower maximum day-care rates, is estimated at 1.2 per cent in March. The total rise in the consumer price index (CPI) was 2.4 per cent, partly as a result of higher electricity prices and a rise in petrol prices.
- According to preliminary national accounts figures, growth in mainland GDP was 3.7 per cent in 2005. Growth in private services, construction and electricity production was strong. Person-hours worked rose by 0.9 per cent.
- The labour market continues to tighten at a rapid pace. According to Statistics Norway's Labour Force Survey (LFS), employment growth picked up markedly towards the end of 2005 and into 2006. LFS unemployment fell further in January, while the number of registered unemployed was approximately unchanged in March (seasonally adjusted). Sickness absence rose again in 2005.
- The wage settlements that have been completed so far may indicate that wage growth, as expected, will be somewhat higher this year than in 2005.
- The Oslo Stock Exchange has risen by 12 per cent since the previous monetary policy meeting and by 27 per cent so far this year. The rise in equity prices is related to strong growth in both reported and expected corporate earnings. Corporate results for the fourth quarter of 2005 were better than expected, and analysts have again increased their expectations concerning the results in 2006 and 2007.
- Adjusted for normal seasonal variations, household goods consumption fell slightly from January to February. Housing starts have edged down somewhat since the beginning of the year. House price inflation accelerated in March. Twelve-month growth in household credit remains strong. Growth in total gross debt for mainland enterprises is showing a pronounced rise. Commercial building starts remain robust. Manufacturing output is expanding.
- Reports from Norges Bank's regional network in March point to solid growth in demand and production in all industries. Growth is expected to remain high over the next six months. About half of the contacts report that they will have some or considerable problems in accommodating an increase in demand. This is a higher share than was the case last autumn. Employment is rising in all industries, including the local government and hospital sectors. Labour shortages have increased over the past six months and are most pronounced in construction, oil-related manufacturing and some service sectors. Our contacts expect higher wage growth this year than in 2005. In retail and the household service sector, only a moderate rise in prices is expected in the near term.
- Financial markets still expect a gradual increase in the sight deposit rate ahead. In line with developments in global markets, the rise in Norwegian long-term interest rates has gathered pace.
Charts - monetary policy meeting (922 kB)
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Charts - monetary policy meeting (170 kB)