According to the monetary policy strategy in Inflation Report 2/06, the sight deposit rate should be in the interval 2¾ - 3¾ per cent in the period to the publication of the next Inflation Report on 1 November, conditional on economic developments that are broadly in line with projections. In the first six months of 2006, the key rate was increased twice by increments of 0.25 percentage point. There are prospects that the interest rate will rise further at about the same pace. In line with this strategy, Norges Bank’s Executive Board decided to raise the sight deposit rate by 0.25 percentage point to 3.00 per cent at its meeting on 16 August. Capacity constraints and a shortage of skilled labour were cited as mounting challenges to a number of industries. At the same  4  BIS Review 80/2006  time, corporate earnings are very high. Local government tax revenues have increased substantially. Household and corporate borrowing remains high. Property prices are rising markedly, and the level of building activity is high. Growth among our trading partners is solid, and a number of countries have raised their policy rates. These factors point to a higher interest rate. At the same time, inflationary pressures, with the exception of energy prices, in the Norwegian economy remain fairly moderate. The krone exchange rate has depreciated recently, but over a period of several quarters the krone has varied around fairly strong levels. Exchange rate movements are difficult to project.
But the Taylor rule is a good test because, other things being equal, the policy rate should be reasonably well in line with it unless there are convincing reasons for a deviation. With this in mind, let us turn to the November interest rate decision. The Monetary Policy Committee decided to raise interest rates by 0.25 percentage points. That decision, of course, was based on the most recent statistics and the indications in the Bank’s forecast. First of all, inflation is far above target and is forecast to continue rising until early in 2012 before tapering off as the year progresses. Second, available measures of inflation expectations indicate that longer-term expectations are considerably above target. These measures of inflation expectations are flawed, of course – perhaps especially so at this time. Survey measures have a tendency to take excessive account of recent inflation, and bond market measures of inflation expectations are skewed by a variety of market imperfections at present. But flawed though they may be, these are the only measures we have, and it would be irresponsible simply to ignore them. Third, indicators suggest that domestic demand was strong in Q3 in spite of the global situation, and that the economic recovery is strong enough not to be derailed by resistance to inflationary pressures through modest rate interest hikes. Fourth, we have the global situation, which is mainly a risk factor at this juncture and has not yet had a measurable impact on domestic economic developments. But we did not merely raise interest rates.