##irable fall in inflation, and that it was therefore likely that short - term interest rates in the us will remain low for a considerable period. interest rates in other countries are also likely to remain low. in the euro area, developments have been considerably weaker, even though there are now signs that the trough has been reached. growth among norway ’ s trading partners as a whole is expected to pick up over the next two years. the reserve bank of australia and the bank of england recently raised their key rates. the interest rate in norway has been lowered substantially. the interest rate cuts must be seen in connection with the change in the inflation outlook, which has occurred as a result of weaker global economic developments and low international interest rates. the key rate has been reduced with a view to bringing inflation back to target at the two - year horizon. moderate pay increases in this year ’ s wage settlements and prospects for wage growth falling to a more sustainable level for a prolonged period have been an important factor behind the considerable easing of monetary policy. an interest rate as low as 2½ per cent, however, largely reflects a long period of low interest rates abroad with little prospect of an increase in the near future in the largest economies. weaker developments both abroad and at home have had an impact on the norwegian labour market. unemployment has increased. decisions concerning saving and investment are affected by the real interest rate, that is the nominal rate minus expected inflation. the real interest rate is also low. an enterprise investing in productive capital will typically apply a longer perspective than a household buying durable consumer goods. enterprises ’ cost estimates will be based on the interest rate and expected inflation in the long term, while short - term interest rates and expectations will be more important to households. monetary policy influences inflation indirectly via domestic demand for goods and services and via its effect on the exchange rate. because changes in the economy take time to feed through, monetary policy functions with a lag. it will therefore take time for all the effects of the substantial changes in the interest rate since december 2002 to come into evidence. when interest rates fall, consumption rises both because disposable income increases and because it is less profitable for households to save. borrowing also becomes less costly, with an associated rise in investment. higher demand leads to higher employment. another important mechanism is that lower interest rates make it less attractive to invest in nok. lower interest rates will therefore normally lead to lower capital inflows and a weaker krone. imported goods thereby

##rone. a krone that is stable - but too strong - also entails costs in the form of low activity. similarly, a krone that is stable but weak - is a source of high inflation. petroleum revenues generally provide substantial, but uneven currency inflows into norway. the currency flows might have resulted in a strong krone and large variations in the exchange rate. this tendency is countered when the annual use of petroleum revenues over the central government budget is predictable and independent of annual revenue inflows, and the remainder is invested abroad. the capital outflow through the petroleum fund contributes to both curbing the appreciation of the krone and maintaining its stability. chart 9. trade - weighted exchange rate index. 1992 week 1 = 100 a. commodity economies b. other economies new zealand australia uk switzerland norway norway canada sweden 1992 1996 2000 2004 1992 1996 2000 2004 sources : bank of england and ecowin norges bank has not defined an exchange rate target. nevertheless, developments in the krone are of considerable importance to interest - rate setting because exchange rate developments have an impact on inflation and output. when there are prospects of moderate economic activity, low wage growth and low inflation, norges bank will reduce the interest rate. this will normally result in a depreciation of the krone. prices for imported goods and services will increase. a weaker krone strengthens the competitiveness of norwegian enterprises and indirectly leads to higher output, employment and inflation. themes in foreign exchange markets shift. in periods, investor focus on stock returns feeds through to exchange rate movements. during periods of political and economic unrest, investors may choose individual currencies as a safe haven - often the swiss franc. in the autumn of 2002, the norwegian krone was probably also perceived as a safe haven. wide fluctuations between major currencies have a tendency to result in a weaker krone. in the past 12 - 18 months, developments in the interest rate differential between norway and other countries appear to have had a particularly marked impact on our currency. norwegian interest rates have been pushed down to the level prevailing abroad. chart 10. exchange rate nok - eur 7, 0 7, 0 7, 5 7, 5 8, 0 8, 0 8, 5 8, 5 9, 0 9, 0 ja n ma r0 ma i0 ju l se p0 no v0 ja n source : ecowin in the autumn of 2003, the krone showed a tendency to appreciate against the euro