Iceland maintains rate but still sees tighter stance

    Iceland's central bank left its key interest rates steady, but said "a tighter monetary stance will probably be needed in the coming term, in view of growing domestic inflationary pressures," but how much and how quickly rates will be raised will depend on future developments.
    The Central Bank of Iceland (CBI), which raised its rate by 125 basis points in 2015,  said global price developments and a stronger exchange rate of the krona had provided scope to raise rates more slowly than previously considered as it lowered its forecast for inflation and raised the forecast for economic growth.
    In its latest monetary bulletin, the CBI forecast average consumer price inflation of 2.3 percent in 2016, sharply down from 3.3 percent seen in November, and 4.1 percent inflation for 2017, down from 4.0 percent, but an unchanged 3.4 percent inflation rate for 2018.
   Iceland's inflation rate rose to 2.1 percent in January from average 2015 inflation of 1.6 percent as the margin of spare capacity in Iceland's economy was estimated to have disappeared last year and is expected to widen even further.
   "Pay rises well in excess of the inflation target and productivity growth exacerbate inflationary pressure, which are offset by developments in global energy and commodity prices and the exchange rate of the krona," the central bank said.
    Unlike most other currencies worldwide, the Icelandic krona has been appreciating against the U.S. dollar since March 2015 and was trading at 126.8 to the dollar today, up 2.4 percent since the start of this year but only up 0.5 percent since the start of 2015.
    The CBI, which targets inflation of 2.5 percent, said the trend of deflation in global goods markets could come to a halt later this year, which would push up inflation though the extent and timing of changes to global prices was uncertain.
    Economic growth in Iceland last year was estimated at 4.1 percent, weaker than the central bank's forecast of 4.6 percent, but growth this year is forecast to rise slightly to 4.2 percent, sharply up from the November forecast of 3.2 percent, as private consumption is expected to rise, pulling up wages, employment and inflation.
    The CBI forecast a 5.3 percent rise in private consumption this year, up from 4.9 percent in 2015, before easing to growth of 4.2 percent in 2017 and 3.4 percent in 2018.
    The CBI left its key rate, the seven-day deposit rate, unchanged at 5.75 percent and the seven-day lending rate at 6.25 percent.


   The Central Bank of Iceland issued the following statement:

 "The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to keep the Bank’s interest rates unchanged. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore remain 5.75%. 

Year-2015 GDP growth is estimated to have been weaker than was projected in the Bank’s November forecast, or 4.1% instead of 4.6%. The outlook is for broadly similar GDP growth this year, or 4.2%. This is 1 percentage point stronger growth than was forecast in November. The difference is due to the prospect of stronger private consumption growth than was projected then, as the outlook is for larger pay increases, more rapid growth in employment, and lower inflation.
The margin of spare capacity is estimated to have disappeared last year, and the outlook is for a widening positive output gap. Pay rises well in excess of the inflation target and productivity growth exacerbate inflationary pressures, which are offset by developments in global energy and commodity prices and the exchange rate of the króna. Inflation has been lower than was forecast in November and appears set to remain so into 2017. 

Deflation in global goods markets could come to a halt, however, and eventually turn around in the coming term. According to international forecasts, this is expected to happen later in 2016. For this reason, among others, inflation is assumed to rise above 3% by end-2016 and reach 4% a year later. The extent and timing of these developments are uncertain, however.

Global price developments and a stronger króna have provided the scope to raise interest rates more slowly than was previously considered necessary. However, this does not change the fact that, according to the Bank’s forecast, a tighter monetary stance will probably be needed in the coming term, in view of growing domestic inflationary pressures. How much and how quickly the monetary stance must be tightened will depend on future developments."

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