The objective of monetary policy is stability in the exchange rate against European currencies. When setting interest rates, the central bank places emphasis on the fundamental preconditions for exchange rate stability. Price and cost inflation must over time be reduced to the level aimed at by the euro area. At the same time, monetary policy must not in itself contribute to deflationary recessions.

The analyses in Norges Bank's inflation reports, together with its continuous evaluation of the outlook for price and cost inflation and conditions in money and foreign exchange markets, provide the basis for decisions regarding monetary policy instruments. Norges Bank's assessment of prospects for economic developments was last presented on 22 June in the Inflation Report. In the report, Norges Bank revised upwards its projections for price and cost inflation in the years ahead. Consumer price inflation was forecast at 3 per cent in 2000 and 2½ per cent in 2001 and 2002.

Recent international and domestic developments support the picture presented in the June Inflation Report.

The international upswing now appears to have gained a broad footing, which is generating positive impulses to Norwegian exports. Stronger growth rates and nascent signs of a faster rate of increase in prices have pushed up short rates internationally since the beginning of the year. Central banks have raised their key rates and market participants expect further increases in interest rates in a number of countries.

The krone exchange rate has appreciated slightly against the euro since Norges Bank's Executive Board last held its monetary policy meeting on 14 June. Norges Bank does not have the instruments to fine-tune the exchange rate, but when setting interest rates the central bank places emphasis on the fundamental preconditions for exchange rate stability over time, ie that price and cost inflation must over time be reduced to the level aimed at by the euro area. In the short term, the effective krone exchange rate is more relevant as an indicator of international price impulses to the Norwegian economy. Measured by the broad import-weighted exchange rate index the krone has depreciated by about 3 per cent since the beginning of the year. The krone exchange rate is thus somewhat weaker than assumed in the June Inflation Report.

The year-on-year rate of increase in domestic consumer prices was 3.3 per cent in June. Underlying price inflation, ie excluding changes in electricity prices and indirect taxes and adjusted for the revision of the house rent index, was 3.1 per cent.

The labour market is tight. The additional vacation days and increased use of various pension arrangements will contribute to restraining the supply of labour over the next two years. Our assessment points to higher growth in wage costs in Norway than in euro area countries. Private consumption and the supply of credit are on the rise. House prices showed a marked increase in the first half of the year.

Output growth in parts of the manufacturing sector is weak and investment activity sluggish, although there are renewed signs of higher growth in credit to the enterprise sector. The high cost level currently prevailing in the business sector may have a dampening impact on growth in the years ahead. However, in the short term there is little risk of a downturn in the economy as a whole.

Today's decision to raise interests rates brings the overall increase in interest rates to 1.25 percentage points from the beginning of the year. This represents a substantial step in the adjustment of the interest rate that is appropriate on the basis of the analyses in the June Inflation Report. However, the probability that the next change in interest rates will be an increase remains greater than the probability of a reduction.