Monetary policy is oriented towards a gradual increase in the interest rate - in small, not too frequent steps. The interest rate was last raised in November. The analyses in the previous Inflation Report implied another increase at the monetary policy meeting in January or March and a further interest rate increase thereafter.

Consumer price inflation was unexpectedly low in December and January, but picked up slightly again in February. Output growth is high, and employment is now 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 objective of bringing inflation back towards the target and anchoring inflation expectations implies a continued expansionary monetary policy.

The overall assessment in the Inflation Report presented today is in line with the strategy in the previous Report. The assessment implies a gradual increase in the interest rate - in small, not too frequent steps - towards a more normal level. The monetary policy strategy 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 the projections.

Outlook and risk factors

The analyses in Inflation Report 1/06 imply that the interest rate should be gradually - in small, not too frequent steps - brought back towards a more normal level. Money market rates among our trading partners are also assumed to rise over the next three years. Such interest rate developments in Norway and abroad may be consistent with an approximately unchanged krone exchange rate.

The high rate of economic growth implies that price and cost inflation will edge up after a period. With a reduction in unemployment, wage growth is expected to accelerate. At the same time, it will probably be easier for enterprises to pass on cost increases to prices in pace with the rise in demand and capacity utilisation. Core inflation is projected to increase from the current level, around 1¼ per cent, and approach 2 per cent at the end of 2007. There are prospects that it will increase further and be close to the target of 2.5 per cent three years ahead.

Capacity utilisation in the economy is expected to rise over the next two years. Even though a gradual increase in the interest rate will curb demand growth after a period, monetary policy will still be expansionary for a period ahead. 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 Executive Board would highlight the following risk factors:

• Consumer price inflation has been unexpectedly low in recent years. If strong shifts in the import pattern continue, it may take longer for the rise in prices for imported goods to pick up. Increased domestic competition with strong productivity growth in some industries has dampened consumer price inflation. Persistently low inflation might imply that the interest rate is rising more slowly than the forecast in the Inflation Report.
• Real interest rates have been very low for a period. With labour market tightening, wage growth has in previous periods shown a rapid and sharp increase. There are some indications that wage growth has picked up for some groups of employees. Economic growth that is stronger than assumed would in isolation suggest a more rapid interest rate increase to prevent resource shortages from increasing and inflation from eventually overshooting the target.

Economic developments

The Executive Board has placed emphasis on the following new information that has emerged since the previous monetary policy meeting:

• The global economic upturn is continuing, with the US, Japan and China making the main contribution. The upswing seems to be broadening to other countries. In the euro area, there is rising optimism in both the enterprise and household sectors. Activity in Sweden is picking up. A number of Asian economies are still showing brisk growth.
• High prices for oil and other commodities have pushed up inflation somewhat in many countries, but there has been no substantial rise in core inflation so far.
• The European Central Bank and the central banks in the US, Canada, Sweden and Denmark have raised their key rates since the end of January. Market participants appear to be expecting interest rates to increase gradually in the period ahead both in Sweden and the euro area. In the US, the key rate is expected to rise by a further 0.25-0.50 percentage point before a peak is reached. In the UK, economic agents envisage approximately unchanged interest rates ahead. Global long-term interest rates have risen slightly.
• The Bank of Japan has changed its operating target for monetary policy. The objective of maintaining a particularly high level of liquidity in the banking system no longer applies. The new operating target is the uncollateralised overnight call rate, which will still be kept at zero per cent. Market participants seem to be expecting the rate to be raised to 0.5 per cent in the course of the next twelve months.
• Equity prices abroad are higher than at the time of the previous monetary policy meeting on 25 January. In Norway, prices have risen by about 7 per cent.
• The price of oil remains at USD 62 per barrel, the same as at the time of the previous monetary policy meeting. Oil futures prices 6-7 years ahead are also at the same level as at the time of the January policy meeting. Figures from Statoil's and Hydro's quarterly reports show that export prices for Norwegian natural gas rose by 28 per cent from the third to the fourth quarter of 2005.
• Measured by the import-weighted exchange rate index (I-44), the krone is about ¾ 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 1.3 per cent in February. Total consumer price inflation (CPI) reached 2.6 per cent, partly as a result of higher electricity prices.
• Figures from both the Directorate of Labour and Statistics Norway indicate that the labour market is now rapidly tightening. In February, there were 19 000 fewer unemployed registered at unemployment offices than one year earlier. Adjusted for seasonal variations, unemployed persons accounted for 2.9 per cent of the labour force. According to Statistics Norway's LFS figures, employment increased sharply around the turn of the year. LFS unemployment has also fallen markedly.
• The Technical Reporting Committee on Income Settlements has estimated annual wage growth in 2005 for employees as a whole at just over 3¼ per cent, which is the lowest figure since 1995. In industries where bonus payments have an influence, wages increased considerably more, but wage growth was low in the hotel and restaurant industry and the construction industry.
• Overall, household goods consumption picked up somewhat in December and January. TNS Gallup's trend indicator, which measures households' assessment of and expectations concerning their own financial situation and the Norwegian economy, fell slightly from the fourth quarter of 2005 to the first quarter of 2006, but remains at a high level. Twelve-month growth in credit to households remains high. The rise in house prices remains at a high level and the number of housing starts is high.
• Manufacturing output has picked up further in recent months. Statistics Norway's investment intentions survey for 2006 indicates that manufacturing investment plans are at about the same level as in 2005. The investment intentions survey for the oil and gas industry indicates that the high investment level in 2005 will be sustained in 2006. According to Statistics Norway's business tendency survey for the fourth quarter of 2005, a high proportion of business leaders expect increased employment. New orders for the manufacturing and construction industries show solid growth. Commercial building starts are at a high level. Growth in total gross debt for mainland enterprises showed a further rise in November.
• Information from Norges Bank's regional network in January and February points to solid growth in demand and production in all industries. About half of the contacts report that they foresee some or considerable problems in accommodating an increase in demand. This is a higher number than previously. The construction industry appears to be operating at capacity limits. Manufacturing also reports that capacity utilisation is high, particularly among suppliers to the petroleum industry. Annual wage growth is expected to be somewhat higher in 2006 than in 2005.
• Financial markets still expect a gradual increase in the sight deposit rate ahead. Market interest rate expectations are somewhat higher than at the time of the previous monetary policy meeting. Long-term interest rates in Norway have to some extent followed the upward movement in external interest rates.

 Charts - monetary policy meeting (977 Kb)
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