Iceland's central bank raised its key interest rates for the second time this year as the outlook for economic growth this year is now better than expected while inflation will ease slightly slower than projected in May.
The Central Bank of Iceland (CBI) raised all its main interest rates by another 25 basis points, including the benchmark 7-day deposit rate that was raised to 1.25 percent and is now up 50 points this year following the first hike in 2-1/2 years in May.
"The economic outlook has improved since the Bank's last forecast," CBI said, raising its forecast for economic growth this year to 4.0 percent in its latest monetary bulletin from the previous forecast of 3.1 percent, mainly due to a rapid rise in tourists to the North Atlantic island.
The stronger outlook for growth comes despite the increased spread of the delta variant of COVID-19, which is expected to dent growth in the third quarter and lower-than-expected economic activity in the first quarter.
Growth in the second quarter, however, was robust, CBI said, reflecting declining infection rates, relaxation of public health measures and rising tourist number.
While the outlook for growth this year was raised, Iceland's economy is seen expanding 3.9 percent in 2022, down from the previous forecast of 5.2 percent, and then 2.2 percent in 2023. In 2020 the economy shrunk 6.6 percent.
"At the same time, a strong recovery of domestic demand and persistent supply-side disruptions caused by the pandemic have pushed commodity prices and shipping costs sharply upwards," the bank said.
Inflation in Iceland has topped 4.0 percent every month this year - it was 4.3 percent in both June and July - and the central bank now expects inflation to average 4.2 percent this year, slightly up from its earlier forecast of 4.1 percent and well above last year's 2.8 percent.
In 2022, however, inflation is seen easing to 2.8 percent and then 2.6 percent in 2023, only slightly above's the bank's target of 2.5 percent.
"The MPC (monetary policy committee) will apply the tools at its disposal to ensure that inflation eases back to the target within an acceptable time frame," 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 raise the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 1.25%.
The economic outlook has improved since the Bank’s last forecast. According to the new macroeconomic forecast, published in the August Monetary Bulletin, the outlook is for GDP growth to measure 4% this year, some 0.9 percentage points above the May forecast. The improvement is driven mainly by tourist arrivals, which have increased more rapidly this summer than was previously expected. Unemployment has subsided more than previously forecast, although it remains high, and the slack in the economy has narrowed more quickly.
A large share of the population is now vaccinated against COVID-19. Even so, case numbers have risen once again, and there is still some uncertainty about the path the pandemic will take, owing to the increased spread of the Delta variant of the virus. Furthermore, the impact of temporary supply chain disruptions abroad, which have pushed manufacturing and distribution costs upwards all over the world, could persist longer than previously anticipated.
Inflation measured 4.4% in Q2/2021 but was 4.3% in July. Overall inflationary pressures appear to be subsiding, particularly according to underlying inflation, but nevertheless remain relatively high. The rise in inflation expectations earlier this year seems to be reversing. According to the Central Bank’s forecast, however, the outlook is for inflation to ease somewhat more slowly than was projected in May. It is expected to remain above 4% through the year-end but align with the target in H2/2022.
The MPC will apply the tools at its disposal to ensure that inflation eases back to the target within an acceptable time frame."
www.CentralBankNews.info
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