The objective of monetary policy is a stable krone exchange rate against European currencies. The Norwegian krone is influenced by a number of factors over which the Norwegian authorities have no control or influence, such as fluctuations in the oil price and international turbulence. In its setting of monetary policy instruments, the Bank places emphasis on the fundamental conditions for maintaining a stable exchange rate over time. Price and cost inflation must be reduced to the level aimed at by the euro countries. At the same time, it must be ensured that monetary policy itself does not contribute to economic downturns with accompanying deflation.

Norges Bank has reduced its interest rates twice previously this year, by a total of 1 percentage point. Since the last interest rate reduction, the krone has appreciated by about 4.5 per cent against the euro. However, this must be viewed in the light of the fact that the oil price has risen within a short space of time from USD 11 to USD 16 per barrel. Domestic factors, including the wage settlement, and the depreciation of the euro against the US dollar may also have played a part.

Norges Bank's evaluation of the economic outlook was last presented in Inflation Report 1999/1. Together with ongoing evaluation of cyclical developments, the analysis in the Inflation Report provides a foundation for decisions regarding the orientation of monetary policy instruments.

Norges Bank stands by the general scenario presented in the last Inflation Report, with a gradual slowing of economic growth and hence of price and cost inflation. This will provide a better foundation for exchange rate stability, making it appropriate to reduce interest rates now.

It is uncertain when the turnaround will occur, and how pronounced it will be. High cost inflation in Norway in 1998 and low product prices internationally are gradually leading to poorer profitability in some business sectors. We expect this to be reflected in lower demand for labour and a decline in investment demand. In particular, the decline in investment in the petroleum sector is expected to contribute to slower production growth in the time ahead.

We expect price inflation to move down towards the level the euro countries aim at during the next two years. The recent strengthening of the krone will be one factor contributing to such a trend. If it has a wide-ranging impact, the central wage settlement in the Federation of Trade Unions/Norwegian Confederation of Business and Industry area may contribute to cost inflation in Norway, too, approaching cost inflation in the euro countries.

At the same time, there is still strong pressure in some areas of the Norwegian economy. Such a trend is not unusual when there is a cyclical turnaround. Developments in credit growth, house prices, retail sales and imports of finished products may be an indication that household demand is growing strongly. On the other hand, a sharp decline in imports of capital goods is a sign of a substantial fall in private sector investment demand.

There is great uncertainty with respect to further developments in private sector consumption. The decline in banks' lending rates and expectations of further reductions in interest rates, combined with house price rises, may contribute to reducing the household saving ratio. Higher private consumption will primarily increase activity in the service industries and in the retail trade.

Markets are expecting substantial reductions in interest rates through the year. These expectations will also find backing in Norges Bank's analyses of the outlook for the Norwegian economy. The greatest uncertainty with respect to the setting of interest rates is associated with developments in the sheltered sector of the Norwegian economy, where pressure on prices remains high. Norges Bank does not have instruments for fine tuning of the exchange rate. The interest rate will gradually be reduced as new information confirms a strengthening of the foundation for exchange rate stability.