Based on these calculations, inflation at end-2007 is projected with a probability of 50 per cent to be between 1.75 and 3.25 per cent. In the Inflation Report, we analysed possible effects on inflation and output based on some alternative assumptions about the functioning of the economy and the current economic situation. It was assumed that the krone exchange rate would remain fairly stable in the period ahead. This assumption was based on pricing in the foreign exchange market. The analyses in the Report show that if the exchange rate appreciates more than this, inflation may be considerably lower than projected. If, for example, the exchange rate appreciates by 5 per cent in relation to the baseline scenario, inflation may stand at 2 per cent at end-2007 - ½ per cent below the inflation target. The change in the interest rate path that will also occur if the outlook for inflation and output changes was not taken into account in these calculations. BIS Review 67/2004  5  As mentioned earlier, the strong krone has a dampening effect on the inflation outlook. This provides a basis for keeping the interest rate level in Norway low for a longer period than would otherwise have been the case and for maintaining this low level even though interest rates rise in other countries. Inflation targeting will therefore ease the pressure on the krone and stabilise exchange rate expectations.
In the first three quarters of 2004, imports increased markedly compared with the same period last year. This may indicate that some of the growth in demand has resulted in an increase in imports instead of higher domestic output. Imports as a share of mainland GDP are rising. This is a result of an increase in the international division of labour, due in part to the removal of trade barriers. The rise in the share of imports must also be seen in relation to low prices for imports from many low-cost countries and the weak competitiveness of domestically-oriented industries. The deterioration in Norway’s competitiveness relative to other countries stems from high wage growth over several years since 1998. The nominal krone exchange rate measured by the trade-weighted index (TWI) is now approximately at the level prevailing in the mid-1990s, while labour costs in manufacturing have risen considerably more than among our trading partners in the same period. The business sector is still burdened with the loss in competitiveness that can be attributed to high wage increases in the period 1998-2002. The exposed sector has been scaled back. Companies that are still in operation may be in a better position to cope with the high wage level. A more efficient service sector may also have strengthened the export industry. Nevertheless, costs may have negative impact on activity and employment.