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Iceland’s Central Bank Cuts Interest Rates

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Iceland’s Central Bank Cuts Interest Rates

Money - Icelandic Króna

Photo: Páll Kjartansson

The Central Bank of Iceland cut its benchmark interest rate by 0.25 percentage points from 6 percent to 5.75 percent in the first cut since 2011 this morning.

A statement from the Central Bank reads as follows:

“According to the Bank’s forecast, published in Monetary Bulletin today, the outlook for 2014 is for somewhat weaker output growth than was forecast in August. Domestic demand growth is still expected to be strong, with robust GDP growth in the next three years. The recovery of the labour market continues as well, although growth in labour demand has lost pace somewhat.

Inflation has been below the inflation target for nine consecutive months and has fallen still further this autumn. Rising house prices have been the main source of inflation, while low global inflation and a stable króna have contributed to low inflation in spite of considerable wage increases. The short-term inflation outlook has therefore improved since August. According to the Bank’s forecast, inflation is likely to fall further in the next few months and remain at or below target through mid-2015. Inflation expectations have fallen in recent months and are approaching the inflation target.

Increased national saving and a larger current account surplus than foreseen in previous forecasts have contributed to continued strong foreign currency inflows, and the Bank has leaned against excessive appreciation of the króna and helped to stabilise the exchange rate.

The Central Bank’s nominal interest rates have been unchanged for two years, but the Bank’s real rate has risen more than previously anticipated, owing to a more rapid decline in inflation and inflation expectations. The monetary stance has therefore tightened more than is warranted by the current business cycle position and the near-term outlook. Containing the rise in the real rate is therefore appropriate.

As always, developments in nominal interest rates will depend on developments in demand and inflation. If pay increases in upcoming wage settlements are consistent with the inflation target, conditions for further reductions in nominal interest rates could develop. Large pay increases and strong growth in demand could undermine the recently achieved price stability, however, and require that interest rates be raised again.”

The Central Bank lowered its forecast for economic growth this year to 2.9 percent from 3.4 percent, as stated in the 2014/4 Monetary Bulletin. Inflation is seen at 2.2 percent this year and 2.6 percent next year. The bank targets 2.5 percent.

The government has said that it is working on a plan to exit capital controls which have been in place since the 2008 financial crash.

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