The objective of monetary policy is low and stable inflation. The inflation target is set at 2½ per cent. The key interest rate is set on the basis of an overall assessment of the inflation outlook, normally two years ahead.

The analyses in Norges Bank's Inflation Report, together with the Bank's current assessment of the outlook for price and cost inflation and developments in the money market and foreign exchange market, provide a basis for decisions concerning the key interest rate.

In its assessment today, the Executive Board placed particular emphasis on the following factors:

The year-on-year rise in consumer prices, as measured by the CPI-ATE, was 1.2 per cent in May 2003, which is lower than the projection in Norges Bank's March Inflation Report and considerably lower than the inflation target. There are also prospects that underlying inflation will be low in the period ahead. The fall in inflation primarily reflects a pronounced decline in prices for imported consumer goods.

So far, oil prices have remained relatively high during the global downturn. To some extent this is insulating the Norwegian business sector. Global developments are nevertheless influencing the Norwegian economy.

The outlook for the global economy is still weak. War, terrorism and the spread of disease have given rise to uncertainty. Substantial spare capacity in the business sector is restraining investment. Growth is low, particularly in Continental Europe, where the fiscal margin of manoeuvre is constrained by high public debt. Inflation is expected to be low among our trading partners and there is growing focus on the risk of deflation in some countries. Key rates have been lowered and there are expectations of further reductions. At the same time, short-term interest rates are expected to remain low for some time ahead, and bond yields are at a historic low. Fiscal policy is expansionary in the US, and a weaker dollar is having a favourable impact on the business sector. Equity prices advanced in the second quarter of this year, but there is no clear evidence that this signals a rapid turnaround in the world economy. Economic policy stimulus is expected to contribute to a gradual improvement in global growth.

The situation in the Norwegian economy has changed over the past year. Capacity utilisation in the mainland economy, which was very high, has fallen and is now in line with that prevailing in 1995-1997 before costs started to rise. Growth in the economy has come to a halt. Even though the krone has depreciated this year, manufacturing sector competitiveness remains fairly weak. Employment in Norway has declined and unemployment has increased. Enterprises are rationalising in many service industries. Public entities have had limited scope for increasing service production because wages have risen. Fiscal policy is having a more neutral impact on total demand. A favourable aspect is that wage growth has moderated. Strong growth in household income last year and the decline in interest rates are sustaining growth in private consumption.

Information from our regional network indicates that economic growth is weak in many business sectors. However, exports are no longer falling. The weakening of the krone has improved earnings in many enterprises.

Monetary policy easing has in some previous cases had a considerable impact on demand and output, and on inflation. Even though the effects of monetary policy occur with a lag, the initial effects have come into evidence quickly. This has not occurred in 2003. Households and the business sector are still predominantly pessimistic. House prices have levelled off and are declining and credit demand is slowing. The krone fell markedly in the first quarter of 2003, but appreciated from March to end-May in spite of the prospect of additional interest rate reductions. This is partly because other countries have also reduced their interest rates. In June, however, the krone again depreciated.

In the Inflation Report presented today, Norges Bank provides an assessment of the outlook for the Norwegian economy. With an unchanged sight deposit rate of 4 per cent and an exchange rate at around the current level, underlying inflation is projected to remain lower than the inflation target over the next two years. The interest rate reductions of a total of 3 percentage points since December last year are expected to result in fairly high growth in private consumption. Business investment will start to pick up again. With an unchanged monetary stance, economic growth will still be so low that production capacity will not be fully utilised in the years ahead.

Even though inflation has been low in recent months, indicators suggest that inflation expectations are fairly stable at around 2½%. The fall in international inflation, as well as continued low inflation in Norway, may reduce expectations. The outlook for the Norwegian and global economy therefore implies that the period of monetary policy easing will continue. Norges Bank is now taking larger steps in interest rate adjustments.

In money and foreign exchange markets, there are expectations of a relaxation of monetary policy both through lower interest rates and a weaker krone. Expectations imply that the sight deposit rate will be lowered towards 3 per cent by the end of this year, and that the krone will gradually fall in value by about 3 per cent in the period to end-2005. Lower unemployment may then lead to a renewed increase in wage growth. Against this background, underlying inflation may be close to target two years ahead. If the easing of monetary policy and employment growth do not translate into higher wage growth, inflation may, even with this path for the interest rate and the exchange rate, remain below target two years ahead.

Given this outlook, there may also be a basis for an easing of monetary policy further than currently implied by expectations in money and foreign exchange markets.

Charts used in connection with the Executive Board's monetary policy meeting:

International economy (197 kB)

Financial markets (296 kB)

Demand and output (82 kB)

The labour market (66 kB)

Prices (124 kB)