The Central Bank of Iceland (CBI) has now cut its seven-day deposit rate by 50 basis points this year following a similar cut in May and reiterated its guidance that its "monetary stance in the coming term will be determined by economic developments and actions taken in other policy spheres."
The CBI added the real rate of interest since the last meeting of its monetary policy committee "entails a somewhat tighter stance than the Committee both had intended and considers sufficient to support price stability."
A rise in the exchange rate of the Icelandic krona over the last two years along with a strong anchor for inflation expectations has allowed the central bank to reach its price stability target with a lower interest rate than otherwise would have been possible.
Iceland's inflation rate eased to 1.7 percent in May from 1.9 percent in April as the krona has been appreciating steadily except for a weakening in the last two weeks. The CBI targets inflation of 2.50 percent.
Last month the central bank lowered its outlook for headline inflation this year to 1.7 percent from February's forecast of 1.9 percent, the 2018 forecast to 2.2 percent from 2.5 percent but then raised its to 3.3 percent in 2019 from a previous 2.8 percent.
The krona was trading at 100.0 to the U.S. dollar today, down from 98.6 at the start of June but still up 13 percent since the start of this year.
"The outlook is for strong GDP growth in 2017, as in recent years," the CBI said, adding the outlook had changed little since its last forecast, with growth still driven by tourism and private consumption while the government is expected to ease its fiscal stance.
In May the CBI's outlook for economic growth was raised to 6.3 percent for this year, up from 5.3 percent previously forecast.
For 2018 the central bank expects growth of 3.5 percent, up from 3.1 percent, and for 2019 2.5 percent, up from 2.6 percent. The 2016 estimate was raised to 7.2 percent from 6.0 percent.
The Central Bank of Iceland issued the following statement:
"The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to lower 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 4.5%.
The outlook is for strong GDP growth in 2017, as in recent years. That outlook has changed little from the Bank’s last forecast, and GDP growth in Q1 was broadly consistent with the forecast. As before, GDP growth is driven in particular by rapid growth in tourism and private consumption; furthermore, the outlook is for considerable fiscal easing this year.
Inflation is still broadly as it has been over the past half-year, but underlying inflation appears to have subsided in recent months. In addition, both short- and long-term inflation expectations have continued to fall since the MPC’s last meeting, and the Bank’s real rate has risen. As before, opposing forces affect the inflation outlook, with the appreciation of the króna and low global inflation offsetting domestic inflationary pressures. The gap between domestic price developments – housing costs in particular – and external factors has widened significantly in recent months.
Clear signs of demand pressures in the economy call for a tight monetary stance so as to ensure medium-term price stability. However, the increase in the Bank’s real rate since the last MPC meeting entails a somewhat tighter stance than the Committee both had intended and considers sufficient to support price stability.
A stronger anchor for inflation expectations at target and the appreciation of the króna have enabled the MPC to achieve its legally mandated price stability objective with a lower interest rate than would otherwise have been possible. The monetary stance in the coming term will be determined by economic developments and actions taken in other policy spheres."
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