The Monetary Policy Committee of the Central Bank of Iceland has decided to keep the bank’s interest rates unchanged, according to the bank’s statement. The key interest rate, which is the rate on seven-day term deposits, will, thus, stay at 5.25 percent.
GDP growth is expected to be robust in 2016 and 2017 and to exceed the bank’s August forecast. It is supported by domestic demand to a greater degree than before. Job creation remains strong and unemployment is declining.
Inflation measured 1.8 percent in October and has been below target for close to three years, although there have been major pay increases and rapid demand growth.
Improved terms of trade, low global inflation, and the appreciation of the króna have offset the effects of wage increases on inflation. A tight monetary stance has helped contain inflation and supported the exchange rate of the króna.
According to the bank’s new inflation forecast, the outlook is for inflation to be below target until mid-2017 and then range between 2.5 and 3 percent for the rest of the forecast period. This is a significant change from the bank’s previous forecast.
The inflation outlook has also improved, especially in the short run.
In recent months, the Central Bank has purchased a smaller share of foreign currency inflows than it did earlier in the year.
The decision to keep interest rates unchanged is based on the bank’s current forecast and risk assessment.
This includes the uncertainty about the fiscal stance, which has eased in the past two years and remains uncertain because it is unclear what the next government’s economic policy will be.
Furthermore, there is unrest in the labor market, not least following the Wage Council’s ruling that provided up to a 44 percent pay raise for elected officials. Moreover, uncertainty remains about the impact of capital account liberalization, although the process has gone well so far. Added to this is uncertainty about the global economic outlook.
Although inflation expectations appear closer to target and the monetary stance has tightened through the appreciation of the króna, strong demand growth and uncertainties call for caution in interest rate policy.