Market interventions in 2000 and 2001 depleted the Central Bank’s foreign reserves, creating a pressing need to strengthen it. The  2  BIS Review 45/2003  Central Bank has been engaged on this task and will continue to do so. It had purchased foreign currency for the equivalent of 30.7 b.kr. since September 2002, which has undoubtedly exerted some impact on the króna in the short run, although the long-term effect is negligible, if any at all. The exchange rate for the króna plummeted in 2000 and 2001, and for quite some time was substantially below a level reconcilable with long-term equilibrium. This occurred at a time when the price of key exports was very high, making the years 2000 and 2001 especially favourable for the export sector and in fact also for import-competing sectors. Enterprises in these sectors understandably felt the effects of the rise in the exchange rate in the first half of this year. It is not to be expected, however, that the same conditions will re-arise in these sectors as prevailed, for example, during 2001 and in the early part of 2002. The exchange rate remained very stable from spring to early winter 2002, when the króna entered a strengthening phase which continued until the beginning of February. The Central Bank has stated its view that the appreciation over this period was primarily the effect of planned aluminium-related investments in East Iceland.
A 2½% increase in public consumption is expected for both years. Gross fixed capital formation, however, is expected to grow by 10¾%, mainly as a result of investments connected with the aluminium industry. Forecast investment in residential housing is 3%. Exports will increase by 2% this year and 4% next year, according to the forecast, due to the increased fishing quotas that I mentioned earlier. Growth of imports is expected to be 4½% this year and 7% in 2004. Despite higher forecast output growth this year, unemployment is expected to be a quarter of a percentage point higher than was forecast in May, at 3¼%. Estimated slack in the labour market this year has been revised upwards. However, unemployment is expected to head down to a figure of 2½% next year. Although higher output growth is expected this year and next year, the output gap is forecast to become slightly negative. A revised estimate now shows a slightly negative output gap last year, which will widen even further in 2003 since output growth is below estimated growth of potential output. The output gap is expected to turn marginally positive next year, when output growth will exceed potential. However, it is important to bear in mind that the evaluation of the output gap is highly uncertain, due to the non-observable nature of potential output. These data do show, however, that good balance is expected in both 2003 and 2004. The Central Bank forecasts inflation up to two years ahead.