Growth prospects for most advanced countries have receded. The risk of a renewed recession within the euro area has increased markedly. Current economic indicators point to an imminent slowdown in Europe, with the German economy also expected to show lower growth. Weaker export demand and heightened uncertainty in financial markets are affecting the outlook for other regions, including a number of emerging economies.

Inflation among Norway’s trading partners remains high, but there are now signs that inflation has started to diminish. Long-term expectations have declined. Market key rate expectations abroad have continued to fall. The European Central Bank (ECB) has reduced its key rate by a total of 0.50 percentage point since October, and has announced measures to ease money and funding market constraints.

Financial market tensions have intensified further since October. Government bond yields in Spain and Italy have risen. At the same time, the turbulence has spread to other government bond markets, such as Belgium, Austria and France. The debt situation in the euro area has led to considerable problems in the European banking system and money and credit markets. The cost of short-term and long-term funding has become steadily higher and less accessible for European banks.

Market funding has also become more expensive and less accessible for Norwegian banks. Banks are expected to tighten lending standards for households and enterprises. Norwegian money market premiums are markedly higher than assumed in the October 2011 Monetary Policy Report. Market participants now expect premiums to remain high in the period ahead. The krone has remained stable despite mounting turbulence.

The outlook for the Norwegian economy has weakened. The enterprises in Norges Bank’s regional network report expectations of slightly lower growth in production over the next half-year compared with that expected in the October 2011 Monetary Policy Report. Other expectations indicators also suggest somewhat lower growth ahead. Moreover, private consumption has been weaker than expected. On the other hand, construction activity has been buoyant and growth in petroleum investment and petroleum-related industries is strong. House prices have risen and household debt is rising at a faster pace than household income. Unemployment has remained stable.

Consumer price inflation has been slightly lower than projected. Underlying inflation is projected to range between 1 and 1½ per cent.

The key policy rate is set with a view to stabilising inflation close to 2.5 per cent over time. At its meeting on 19 October, the Executive Board decided that the key policy rate should be in the interval 1¾ - 2¾ per cent in the period to the publication of the next Monetary Policy Report on 14 March 2012, unless the Norwegian economy is exposed to new major shocks.

Inflation is low while capacity utilisation in the economy is close to a normal level. Developments abroad and in financial markets imply slower growth in output, employment and lower inflation at home. Furthermore, in a situation with elevated uncertainty, it may be appropriate to take measures to mitigate effects of a particularly adverse outcome on the economy. The Executive Board is of the view that it is appropriate to reduce the key policy rate now in order to guard against an economic setback and even lower inflation.

Decision
The key policy rate is reduced by 0.50 percentage point to 1.75 per cent  with effect from 15 December 2011.