The real krone exchange rate as measured in terms of developments in relative prices is an expression of the Norwegian krone’s purchasing power. When the curves in the chart are above zero, the exchange rate is stronger and competitiveness weaker than the average level since 1970. The real exchange rate has fluctuated considerably over time and has deviated substantially from the average level over longer periods. Nevertheless, there has been a tendency for the real exchange rate to revert to this level. In the chart, the point for 2004 shows the real exchange rate with wage and inflation projections for 2004 from Inflation Report 1/2004. In relative prices, the real exchange rate is now about 2 per cent weaker than the average since 1970, whereas it is almost 4 per cent stronger than its historical average measured in terms of relative labour costs. Economic developments Interest rate expectations have been revised upwards in a number of countries. Growth has picked up in the US. As in the second half of 2003, growth is primarily being driven by private consumption and business investment. Following a surprisingly long period of weak labour market developments, employment has begun to edge up and is now higher than at the same time last year. In recent months, inflation has increased from a very low level. As a result, interest rate expectations have been revised upwards, and the key rate in the US is expected to be raised at the end of June.
While this is definitely a concern for every country, we open-economy EMs are especially concerned about how SMEs—particularly medium-size firms—would cope with the trade and supply chain disruptions. Medium-size manufacturing firms are the backbone of EM economies. Prior to the onset of the trade tension, the new global environment has already brought upon these firms considerable pressure. Technological disruption tends to favor large corporations who better understand the technology and have the resources needed for the adaptation. Low interest rate environment also allows large firms to access bond financing at very low  1  funding costs. These factors have increased market power of large firms and forced smaller firms to quickly redefine their business model in order to stay afloat. Amidst these structural changes, the ongoing trade tension becomes an additional burden to medium-size firms’ survival both directly and through the disruption of the supply chains. Moreover, the increased uncertainty that forces firms to diversify their production locations and hedge against the growing risks together with the ongoing economic downturn have squeezed the profit margins. In such a circumstance, mediumsize firms are in a much more difficult position than large firms that have deeper pockets and larger buffers. Trade tension might be comparatively short-lived when compared to other structural changes like demographic shift and technological disruptions, but these short-term factors could result in a long-term impact to medium-size firms and the structure of the economy through channels such as changes in competition landscape, market dominance power, and investment and employment patterns.