The Government has defined an inflation target for monetary policy in Norway. The operational objective is an inflation rate of 2½ per cent over time. In general, the direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties and extraordinary temporary disturbances are not taken into account. Norges Bank places particular emphasis on CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) when assessing underlying inflation.

Normally, Norges Bank sets the interest rate with a view to achieving an inflation rate of 2½ per cent two years ahead. However, it would in general have been possible to attain the inflation target in the nearer term by changing the interest rate more rapidly and more markedly. Norges Bank has therefore chosen to operate a flexible inflation targeting regime where variability in both output and inflation are given weight. The choice of horizon is based on a perception of how interest rates influence the path of inflation and output, and the central bank's approach to striking a balance between the variability in these two variables.

At its meeting of 17 September 2003, the Executive Board decided to reduce the key rate from 3 per cent to 2.5 per cent. It was also stated that, according to Norges Bank's assessment, with an interest rate of 2.5 per cent, the probability that inflation two years ahead would be higher than the target was the same as the probability that it would be lower.

The prospect of low inflation and low economic growth has led to a considerable easing of monetary policy since December 2002.

In the current assessment of interest rates, the Executive Board has placed particular emphasis on the following factors:

• CPI inflation adjusted for tax changes and excluding energy products (CPI-ATE) has slowed gradually since the summer of 2002. The year-on-year rise in the CPI-ATE was 0.9 per cent in September. Inflation has been somewhat lower than we projected in the June Inflation Report. Low inflation abroad and the appreciation of the krone until January 2003 have resulted in declining prices for imported consumer goods, but these prices are now falling at a slower pace. The rise in prices for domestically produced goods and services has slowed in recent months.
• The interest rate reductions have narrowed the interest rate differential between Norway and other countries. As measured by the import-weighted index (I-44), the krone has depreciated by 9 per cent since the beginning of the year. Inflation is expected to move up as a result of the depreciation of the krone. A higher level of activity in the Norwegian economy will also gradually push up inflation. The easing of monetary policy will initially stimulate private consumption, which will lead to increased activity in industries that supply goods and services to households. A weaker krone will also contribute to higher exports. As international demand gradually picks up and excess capacity in service industries is reduced, demand for labour may rise in several sectors of the economy. Unemployment is projected to edge down again.
• Activity in the global economy has picked up from the low level prevailing last winter, primarily reflecting high growth in the US and some Asian countries, including Japan. In the euro area, developments have been considerably weaker, even though there are now signs that the trough has been reached. Growth among Norway's trading partners as a whole is expected to strengthen over the next two years.
• Oil prices have remained higher than USD 25 since the June Inflation Report and been about USD 30 in recent weeks. This reflects OPEC quota discipline, continued low oil stocks in the OECD area, particularly in the US, and lower-than-expected oil supply from Iraq.
• Petroleum investment is projected to increase markedly both this year and next. Even though imports will cover a high share of this investment, it will contribute to sustaining activity in manufacturing enterprises that supply goods and services to the petroleum sector. Looking further ahead, petroleum investment is expected to show a fairly pronounced decline.
• In the central government budget for 2004, the Government proposes a 5.4 per cent increase in public spending, which is somewhat higher than projected trend growth in the value of mainland GDP. The tax level remains unchanged in real terms. For 2003 and 2004 as a whole, fiscal policy will generate some stimulus to activity in the Norwegian economy.
• Norges Bank's regional network confirms that the fall in employment is moderating, but there are few businesses with plans to increase employment ahead. The regional network also reports that cost cuts in the business sector, particularly in service industries, are now yielding results in the form of improved profitability. The focus appears to have shifted to some extent from cost cuts to strategies for boosting revenues.

The stimulus from monetary policy now appears to be feeding through, both via the reductions in the interest rate and a weaker krone. There are now emerging signs that activity in the Norwegian economy is picking up. However, it may take time for higher demand and production to have a substantial impact on employment and investment. The business sector is still feeling the effects of the sharp rise in labour costs over several years. At the same time, there is still excess capacity in a number of industries. A rise in demand can probably be accommodated to some extent using existing capacity. After a period, however, higher demand is likely to lead to renewed growth in employment and investment. Lower wage growth in the local government sector and other public entities will improve their financial position and gradually create scope for higher employment.

All in all, mainland GDP is projected to expand by ¾ per cent in 2003. Growth was approximately zero in the first half of the year, but is projected to pick up in the second half. Mainland GDP growth is projected at 3 per cent in 2004 and 2¾ per cent in 2005. In 2006, mainland output is expected to increase just below trend growth, which we estimate at 2½ per cent. This path for overall production implies that the output gap, as estimated here, will be marginally positive next year and in 2005 and 2006. In the analysis in the Inflation Report, inflation returns to target in autumn 2005 and stabilises at this level.

The Executive Board regards the following factors as particularly uncertain:

• Growth in credit to households, which has abated since spring 2002, may again accelerate. A renewed rise in house prices and the debt burden may lay the basis for new imbalances in the economy. Growth in credit to enterprises remains very low, however. This reflects imbalances between households' financial position and the financial position of some business sectors.
• The projections are based on the assumption that overall labour market conditions are the main determinant of wage growth. It is conceivable, however, that profitability in internationally exposed industries will again play a more prominent role in wage determination ahead than has been the case in recent years. In that case, overall wage growth might be lower than projected and lay the basis for an easing of monetary conditions.
• The global economy appears to be vulnerable to new disturbances. Since the summer, developments in international financial markets have reflected growing optimism concerning growth prospects. Equity prices and long-term interest rates have increased. However, the increase has been uneven and there have been wide fluctuations between major currencies. This may reflect uncertainty as to the resilience of the global economic recovery.
• The reduction in interest rates and the depreciation of the krone imply that inflation will gradually move up and be considerably higher as early as next spring. After a period of very low inflation as we have now witnessed, it is appropriate to be particularly vigilant in monetary policy in the event that inflation does not increase as projected.

Against the background of the Inflation Report, which is being published today, the Executive Board has made the following assessment:

• The aim of monetary policy in the period ahead is higher price inflation. The analysis in the Inflation Report indicates that inflation will move up and stabilise around the inflation target two years ahead. The real economy is projected to move on a balanced path. The analyses are based on the technical assumption that the interest rate moves in line with forward rates in the money market and that the krone depreciates. This implies that the interest rate will remain at approximately the current level in the first half of 2004 and then rise gradually in pace with interest rates abroad. The forward exchange rate implies a depreciation of the krone of close to 2 per cent from the average for the past three months. Such a path for the interest rate and the exchange rate may be consistent with the objective of monetary policy, and will probably contribute to keeping inflation expectations at around 2½ per cent.
• Economic developments have been broadly in line with the assumptions underlying the assessment at the last monetary policy meeting of 17 September. Monetary policy affects the economy with a lag. It will take time for all the effects of the pronounced shift in monetary policy since December 2002 to come into evidence. We have limited experience as to the effects of such a pronounced shift. Further interest rate changes are therefore not warranted at present.

Charts - monetary policy meeting and press conference