After it became clear that Russia would not, in practice, be servicing its foreign debt, market participants became highly risk-averse. The unrest spread to European BIS Review 10/1999  –6–  financial markets and Norway. Investors fled to safe-haven countries such as Germany, the US and Switzerland, and the currencies of countries with less liquid and more volatile financial markets depreciated. This included countries such as Norway and Sweden. The Norwegian krone depreciated sharply from around 101 against the ECU index at the beginning of the year to 115 in October, or the weakest rate since the objective of exchange rate stability against the ECU was adopted. 6) Monetary policy in 1998 Norges Bank responded to the sharp depreciation of the krone by raising its key rates in several steps in 1998. These rates were first raised in March, after the krone weakened in the first three months of the year from 101 to about 103.5 against the ECU index. The krone then appreciated slightly and stabilised for a period. Pressure on the krone increased during the summer. Norges Bank responded by raising its key rates on six further occasions. Following the last increase on 25 August, the deposit rate and the overnight lending rate were 8 and 10 per cent, respectively, i.e. 4.5 percentage points higher than at the beginning of 1998. It is difficult to predict the direct short-term effect of changes in interest rates on the exchange rate.
9) Formulation of monetary policy Norges Bank reduced its key rates by 0.5 percentage points effective from today. This decision came in response to developments in money and foreign exchange markets and the prospect of reduced pressures in the real economy. The outlook for the Norwegian economy has changed since Norges Bank raised its key rates in August. The forecasts for growth in the world economy have been revised downwards and persistently low oil prices have reduced demand in the oil sector. In addition, a tight government budget for 1999 and the high interest rate level are having a restraining effect on growth. At the same time, the krone has appreciated recently. This lays the foundation for slower price and wage inflation in the years ahead, as estimated by Norges Bank in its December Inflation Report. Developments in recent weeks have confirmed this picture, providing room for a slight reduction in interest rates. According to the Exchange Rate Regulation, “... in the event of significant changes in the exchange rate, monetary policy instruments shall be oriented with a view to returning the exchange rate over time to its initial range”. The guidelines provide considerable scope for discretion in the conduct of monetary policy. It is Norges Bank’s task to exercise this discretion. Interest rates are set with a view to returning the krone exchange rate over time to its initial range. Even with this interest rate reduction, the interest rate differential against European countries is substantial.