. flexible inflation targeting builds a bridge between the longterm objective of monetary policy, which is to keep inflation on target and provide an anchor for inflation expectations, and the more short - term objective of stability in the real economy. this contributes to predictability for those who take decisions about saving and investment today, although the result of those decisions depends on how the economy develops in the future. monetary policy must strike a balance between the various objectives. strong growth in the norwegian economy, a tighter labour market, a pronounced rise in equity prices and high credit growth must be weighed against unexpectedly low inflation. norges bank ’ s projections in the inflation report are based on an interest rate path that in the executive board ’ s assessment strikes a reasonable balance between the objectives of monetary policy. previously, we based our analysis on various technical assumptions concerning future interest rates. one such assumption was market interest rate expectations. as from late last year, we now base our projections on an interest rate path that we consider reasonable. this gives norges bank more active ownership of the projections that are presented and of the uncertainty we believe surrounds these projections. in the baseline scenario presented in inflation report 1 / 06, interest rates in norway and abroad are assumed to rise somewhat faster in the longer term than current forward rates may imply. exchange rate movements are difficult to project. the interest rate path at home and abroad may be consistent with an approximately unchanged krone exchange rate. the high growth rate in the economy implies a gradual pick - up in price and cost inflation. with interest rate developments as outlined above, core inflation is projected to increase from about 1¼ per cent today to about 2 per cent at the end of 2007. there are prospects of a further increase in inflation, with inflation projected to be close to the target of 2. 5 per cent three years ahead. the output gap is expected to increase over the next two years, but will peak at a fairly moderate level as gradual increases in the interest rate dampen demand growth. on the basis of the analysis in the inflation reports, norges bank ’ s executive board assesses the consequences for future interest rate development and adopts a monetary policy strategy for the period to the next report. interest - rate setting since last summer has been oriented towards a gradual increase in the interest rate – in small, not too frequent steps – towards a more normal level. based on norges bank ’ s assessment of the driving forces in the economy, this strategy appears robust. output growth is strong

and labour costs in distributive trades has also been high the last five years, with an average wage growth per normal person - year of 5 per cent, the same as for mainland norway. national accounts figures for service industries are more uncertain than figures for manufacturing industry. measuring productivity in service industries is difficult. the chart shows that according to the national accounts, productivity growth is very volatile. if we smooth the data somewhat, it appears, however, that productivity growth has been relatively high through the 1990s, following low growth at the end of the 1980s. at the very end of the 1990s, however, productivity growth was weak. one source that may be used to analyse developments in distributive trades is norges bank ’ s database sebra which contains figures for all limited companies that have turned in valid accounts to the brønnøysund register. the figures, from 1988 to 1999, show that profitability in this industry has been positive since 1993. both measures of profitability show a slightly falling trend from the peak year 1994 to 1998. in 1999, it appears that profitability improved again. the increase in profitability from the end of the 1980s to the mid - 1990s reflects a structural development in the industry since the 1980s. the most important changes were the emergence of chains and the development of shopping centres. when the upturn came in the mid - 1990s, a better structure was in place. both the chains and the shopping centres have increased their market shares. this structural development has probably made it possible to maintain satisfactory profitability at the same time that profit margins have declined. operations became more efficient. profitability has been satisfactory despite lower mark - ups on the cost of goods. in 1998 and 1999, however, profit margins increased somewhat. the higher profit margins since 1997 may reflect the greater concentration in the grocery trade. profit margin is defined as operating income less cost of goods as a percentage of operating income. labour cost growth and wage costs as a share of income in distributive trades declined sharply until the mid - 1990s and have since picked up. this had the opposite effect on operating margins, which fell in the five years to 1999. one possible explanation is that weaker competition in distributive trades the last few years has made it possible to increase profit margins without losing market shares and thereby weakening profitability. this may also have contributed to the industry ’ s role of spearhead in the wage settlement in 1998. however, a fresh