Consumer price inflation remains moderate, but there are prospects that inflation will gradually pick up. The interest rate is being raised so that inflation will not become too high. The interest rate will be increased gradually so that we can assess the effects of interest rate changes and other new information on economic developments.

Recent credit and stock market turbulence has generated uncertainty concerning future economic developments, but on balance new information since the previous monetary policy meeting does not now warrant a departure from the monetary policy strategy presented in June. According to the strategy in Monetary Policy Report 2/07, the key policy rate should be in the interval 4½ - 5½ per cent in the period to the publication of the next Report on 31 October, conditional on economic developments that are broadly in line with projections. Given the inflation target, we will be mindful of the effects of higher interest rates on the krone exchange rate when inflation is low.

Outlook and risk factors

In Monetary Policy Report 2/07, inflation measured by the CPI was projected to pick up markedly next year from a very low level this year. Underlying inflation remains in the range between 1 per cent and 1½ per cent as it has for some time. The rise in the CPI adjusted for tax changes and excluding energy products (CPI-ATE) is expected to pick up to around 2 per cent in the latter half of 2008. Capacity utilisation is currently at such a high level that inflation is projected to gradually move up to 2.5 per cent. At the same time, the increase in interest rates will lead to a gradual fall in capacity utilisation so that inflation does not become too high.

In the Report, it was noted that new information may reveal aspects of economic developments that indicate that the Norwegian economy is moving on a different path than projected. On the one hand, high capacity utilisation and higher cost inflation may lead to higher-than-projected inflation. On the other hand, sustained high productivity growth, a more pronounced shift towards imports from low-cost countries and a stronger krone exchange rate may result in lower-than-expected inflation.

Since the publication of the previous Report, consumer price inflation has been somewhat lower than projected, primarily reflecting a lower-than-expected rise in prices with wide monthly variations. Growth in goods consumption, employment and the supply of labour has been stronger than projected. Financial markets have been very volatile. The weakness in the US housing market is still fuelling uncertainty about economic developments ahead. At the same time, growth is strong in China and India and there is an upturn in Europe. Moreover, growth in the international economy may be less dependent than earlier on demand for goods and services in the US. There is nevertheless a risk that uncertainty and volatility in financial markets will have spillover effects on growth in the world economy.

Economic developments

• The Executive Board has placed emphasis on the following new information since the previous monetary policy meeting on 27 June:
  Global growth remains high. Economic growth in China and India appears to be stronger than expected. The upturn in Europe is continuing even though euro-area growth was somewhat weaker than expected in the second quarter. In the US, the picture has been mixed and the US housing market has weakened.
• Developments in the US housing market have led to heightened uncertainty in credit and stock markets. Losses associated with defaults on subprime loans have increased risk premia in credit and bond markets. Equity prices have declined. Several central banks have injected extra liquidity into the banking system. Norges Bank provided liquidity to the Norwegian banking system through ordinary market operations on 9 August.
• The central banks in the UK, Canada, New Zealand and Australia have raised their official interest rates. In financial markets, short-term interest rate expectations have fallen, particularly in the US. Long-term interest rates have also declined. Interest rate expectations in Norway have fallen somewhat less.
• The spot price of Brent Blend oil is now about USD 70 per barrel. The futures price at end-2009 is USD 69 per barrel. A weighted average of Statoil and Hydro’s selling price for gas fell in the second quarter. Compared with the fourth quarter of 2006, the gas price has dropped by more than 20 per cent in NOK terms. According to the Norwegian Petroleum Directorate, Norwegian petroleum production shrank by a little more than 4 per cent in the period January-May this year compared with the same period one year earlier. Preliminary figures for June show a further drop in oil production due to planned maintenance at several fields. 
• The import-weighted krone exchange rate has appreciated by about 0.6 per cent.
• The year-on-year rise in the consumer price index (CPI) was 0.4 per cent in July, unchanged on June. Adjusted for tax changes and excluding energy products, the rate of increase in consumer prices (CPI-ATE) was 1.4 per cent over the past twelve months. The rise in prices measured by a trimmed mean of the rise in the sub-indices in the CPI was 1.1 per cent, while a weighted median showed a rise of 1.5 per cent.
• External trade statistics show that prices for traditional export goods rose by 6.0 per cent between the second quarter of 2006 and the second quarter of this year. Import prices, excluding energy prices, rose by 9.0 per cent in the same period.
• In July, seasonally adjusted registered unemployment stood at 1.9 per cent of the labour force, unchanged on the previous month. As measured by Statistics Norway’s labour force survey (LFS), seasonally adjusted unemployment was 2.5 per cent in May (three-month period April-June). Employment increased by 19 000 persons on the previous three-month period (January-March), while the labour force expanded by 15 000 persons in the same period.
• Manufacturing production increased by a seasonally adjusted 0.8 per cent from the first to the second quarter of this year. Statistics Norway’s business tendency survey for the second quarter of 2007 confirms a continued increase in production volume, stock of orders and manufacturing employment.
• Twelve-month growth in gross domestic debt of non-financial enterprises was 20.9 per cent at end-June, unchanged on May. The corresponding figure for the money supply was 26.1 per cent in June, down from 29.6 per cent at end-May.
• Household net borrowing was NOK 83.6 billion over the four quarters to the first quarter of this year. Household net assets still increased by NOK 8.6 billion in the same period as a result of price gains. Twelve-month growth in household gross domestic debt was 12.1 per cent at end-June, unchanged on May. Statistics Norway’s stock statistics show that dividends for households were considerably lower in 2006 than indicated by preliminary institutional sector accounts figures. The household saving ratio for 2006 may on this basis be recorded as negative for the first time since 1988.
• Household spending on goods increased by a seasonally adjusted 2.3 per cent in June, after rising by 1.0 per cent in the previous month (revised up from 0.4 per cent). Leisure articles, including boats, and clothing and footwear were among the goods that showed the strongest increase. The volume of retail sales, excluding motor vehicles and petrol, rose by 4.7 per cent in the same period adjusted for seasonal patterns, after falling by 0.4 per cent between April and May.
• Statistics from the real estate industry show that house prices edged down between June and July and were 11.3 per cent higher than in July 2006. According to building area statistics, housing starts rose by 18.5 per cent in the year to May 2007. Measured by utility floor space, the increase was 17.3 per cent. The year-on-year rise in the cost index for housing construction was 7.8 per cent in July, down from 7.9 per cent in June.

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