The Central Bank of Iceland (CBI), which has cut its key rate by 50 basis points this year, also said demand pressures in the economy call for a tight monetary stance to ensure price stability but reiterated that future changes to its monetary policy would be determined "by economic developments and actions taken in other policy spheres."
Iceland's economy is booming due to tourism, which has fired up private consumption. But inflation has remained under control due to the strong exchange rate of the krona, which has kept down import prices, and low global inflation.
But the CBI noted the foreign exchange market had been volatile and while "changes in external trade and the housing market could be in the offing," it added that it was too early to draw any conclusions about the scope and implications of such changes.
Since the previous meeting of the central bank's monetary committee in June, when the CBI cut its rate for the second time this year, the Icelandic krona has depreciated, pushing up short-term inflation expectations slightly.
But the krona still remains 5.2 percent higher than at the start of this year and was trading at 107.4 to the U.S. dollar today, with long-term inflation expectations largely unchanged.
In an update to its forecast, the CBI lowered its projection for 2017 growth to 5.2 percent from May's forecast of 6.3 percent on lower growth in exports while private consumption is seen rising 7.1 percent, up from a previous forecast of 6.7 percent.
In 2018 Iceland's economy is seen cooling, with Gross Domestic Product forecast to rise by 3.3 percent, down from the previous forecast of 3.5 percent, and then by 2.5 percent in 2019, unchanged from May. In 2016 Iceland's economy grew by 7.2 percent as private consumption rose 6.9 percent.
In the first quarter of this year, Iceland's GDP expanded by 5.0 percent on an annual basis, down from 11.3 percent in the previous quarter.
Inflation in Iceland rose in July to 1.8 percent from June's 1.5 percent with inflation forecast by the CBI to average 1.8 percent this year, slightly up from 2016's 1.7 percent, and down from its previous forecast of 1.9 percent.
Next year inflation is seen accelerating to 2.5 percent, in line with CBI's 2.50 percent target, and up from its previous forecast of 2.2 percent. In 2019 inflation is seen rising further to 3.3 percent.
"The gap between domestic price developments - housing costs in particular - and external factors has continued to wide in recent months, exacerbating uncertainty about the near-term inflation outlook," the CBI said.
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 4.5%.
The outlook is for GDP growth to be strong this year, as it was in 2016, albeit somewhat weaker than was forecast in the May issue of Monetary Bulletin. GDP growth is driven in particular by growth in tourism and private consumption; furthermore, the outlook is for fiscal easing this year.
Inflation was marginally lower in Q2 than was projected in May. It measured 1.8% in July, up from 1.5% in June. Underlying inflation appears to have continued to fall, however. The króna has depreciated since the MPC’s last meeting but remains almost 8% stronger than it was a year ago. As before, opposing forces affect the inflation outlook, with the appreciation of the króna in the past year and low global inflation offsetting domestic inflationary pressures. The gap between domestic price developments – housing costs in particular – and external factors has continued to widen in recent months, exacerbating uncertainty about the near-term inflation outlook.
Since the MPC’s last meeting, short-term inflation expectations have risen slightly, probably reflecting the impact of the recent depreciation of the króna. Long-term inflation expectations are broadly unchanged, however, according to the Central Bank’s most recent survey of market agents’ expectations. The long-term breakeven inflation rate in the bond market has risen in the past few days, although it has been well in line with the inflation target over the quarter to date.
Demand pressures in the economy call for a tight monetary stance so as to ensure medium-term price stability. The foreign exchange market has been volatile, and there are signs that changes in external trade and the housing market could be in the offing. It is too early to draw conclusions about the scope and implications of such changes, however. The Bank’s real rate has eased slightly since the last MPC meeting but, under current conditions, appears to be at a level ensuring inflation broadly at target. The monetary stance in the coming term will be determined by economic developments and actions taken in other policy spheres."
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