The objective of monetary policy is stability in the exchange rate against European currencies. 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: price and cost inflation must over time be brought down towards the corresponding aim for inflation for the European Central Bank (ECB). 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 concerning monetary policy instruments. Norges Bank's assessment of prospects for economic developments was last presented on 21 December 2000.

In the December 2000 Inflation Report, consumer prices were projected to rise by 3 per cent in 2001 and 2½ per cent next year. Price inflation in the period 2003-2004 was projected at an average of 2¼ per cent. The inflation projections are based on the assumption that interest rates move in line with market expectations, as implied by forward rates on 14 December. The fall in forward rates was so pronounced that this influenced the inflation projections and the economic scenario presented in the report. Given an approximately unchanged interest rate, the inflation projection would be a little less than 2 per cent from the end of 2002.

The effective import-weighted krone exchange rate, which is an indicator of international price impulses affecting the Norwegian economy, has appreciated somewhat since the last monetary policy meeting on 13 December 2000, but is almost 2 per cent weaker than it was at the beginning of 2000. The euro has appreciated considerably against the US dollar in recent weeks. The krone has depreciated against the euro since the December meeting and is almost 2 per cent weaker than at the beginning of 2000.

The expected slowdown in world economic growth now appears to have commenced. Short-term statistics for the US now provide growing evidence of more moderate growth. In order to prevent the economy from slowing down too fast, the Federal Reserve lowered its target for the federal funds rate by half a percentage point to 6 per cent on 3 January. The recent fall in oil prices will also contribute to reducing the risk of a sharp turnaround internationally.

The situation in the Norwegian economy has not changed markedly since the December 2000 Inflation Report. Price inflation is high. The year-on-year rise in the consumer price index was 3.0 per cent in December. The underlying rise in prices, ie excluding indirect taxes and changes in electricity prices and adjusted for the revision of the house rent index, stood at 2.8 per cent. On average, prices rose by 3.1 per cent from 1999 to 2000. The underlying rise in prices was 2.9 per cent. If changes in petrol prices are also excluded, price inflation was 2.4 per cent.

The labour market remains tight. Credit growth is still high. House prices appear to be stabilising. Growth in goods consumption has moderated. Slower growth in the global economy may also contribute to reducing growth in the Norwegian economy.

In the light of recent trends in the economy and the current balance of risks, the probability that the next change in interest rates will be a reduction is the same as the probability of an increase.