central bank policy. each inflation forecast is projected two years ahead, quarter by quarter. as in all countries, changes in the central bank interest rate are transmitted to the economy with a considerable lag. monetary policy therefore needs to be forward - looking and the inflation forecast based on the best available methodologies. if the scenario is that inflation will head beyond the bank ’ s target, the bank will raise its interest rates, while it will reduce them if inflation is tending below the target. let us first look at the macroeconomic forecast, which of course is a major consideration for future inflation. the main assumptions are that the central bank ’ s policy interest rate, currently 5. 3 %, will remain unchanged for the forecast period, which is a standard forecasting assumption, and that the exchange rate will be 3 % weaker than in the february forecast, with a reference value of 124. however the exchange rate index has continued to rise [ i. e. the krona weakens ] and currently stands at 128. another assumption is that fiscal policy will not deliver a stronger demand impulse than has already been decided. in other words, the fiscal stance will be relatively neutral, apart from a considerable increase in public sector investment this year and a contraction next year. this implies that the treasury balance will not be disrupted by discretionary measures on the expenditure and revenue side. public consumption is expected to be below the historical average. on the basis of current assumptions for the development of external conditions this year and in 2004, prices of marine products are now expected to fall by 4 % this year and to remain unchanged between 2003 and 2004. exports of marine products are expected to grow by 3 % this year due to increased quotas for the fishing year [ beginning september 1 ] and a larger blue whiting harvest this summer. the assumed increase in catch volume for 2004 is 5 %. aluminium prices are expected to rise by 4 % this year, based on futures prices and the pricing assumptions of the two aluminium companies, norðural and alcan iceland. import prices in foreign currency are expected to decrease by ½ %. fuel prices are based on futures. these have been on an upward trend in recent weeks and are now expected to rise by 9 % this year but fall by 14 % in 2004. the terms of trade for goods and services are expected to deteriorate by 1½ percentage points this year. in 2004 they are expected to improve by three - quarters of a percentage point. assumptions for short - term

, especially abroad. although the main function of a financial stability report is to highlight risks, factors conducive to strengthening the long - term economic outlook should also be duly noted. iceland ’ s economy is advanced, transparent and dynamic. the population is relatively young, well educated and quick to adapt to technological and scientific innovations. a strong fully funded pension system has been built up and, unlike other countries, there is no reason to fear for its sustainability. gdp per capita ranks with the highest in the world, and the economic and social infrastructure is solid. the openness of the economy results in a smaller effect from a contraction in domestic demand on employment than might be expected. the authorities shape the framework in which businesses and the financial system operate. through its membership of the european economic area, iceland enjoys similar operating conditions to those within the european union. nonetheless, it retains various features that influence economic advancement, such as a rather business - friendly tax environment, efficient public administration and flexible labour market. extensive and rapid transformation of the financial sector puts supervisory agencies under pressure. the financial supervisory authority ( fme ) has been granted an increasingly wide remit in recent years and its activities have been strengthened. one task is to monitor the banks ’ transactions with main shareholders and executives. payment and settlement systems are a key component of an efficient and sound financial system. steps have recently been completed towards bringing their regulatory framework into line with international best practice. although such work tends to go relatively unnoticed, it is crucial for enhancing security of settlements and reducing technical risks. the main financial sector vulnerabilities are presented in the table below. the first three relate to macroeconomic imbalances that could cause a further widening of the current account deficit, higher external debt and a depreciation of the krona. vulnerability on these counts is no less than a year ago, and higher global interest rates and premia could have widespread repercussions. on the other hand, much of the uncertainty about the banks ’ access to financing has been dispelled and they have built up ample liquid reserves. under such conditions, the focus shifts to asset quality. the second table highlights factors that contribute to financial system resilience. the most noteworthy development is the banks ’ stronger position in the form of ample liquidity and capital adequacy ratios which are very acceptable and historically high. on the whole, the central bank ’ s finding is that the financial system is broadly sound. it is equipped to withstand shocks