Central Bank of Iceland: Benchmark Interest Rate Kept at 6.0%

February 6, 2013

The 7-day Icelandic collateralized interest rate was previously raised from a base of 4.25% by 25 basis points in August and November of 2011, then by 25 bps in March 2012, by 50 bps in May, 25 bps in June and, most recently, by 25 bps last November to 6.0%.  While keeping that level after today’s policy meeting, officials released a statement that expressed concern about the Icelandic krona, pronounced the inflation outlook broadly unchanged, and predicted additional withdrawal of monetary accommodation in the future.

Poorer terms of trade have reduced the trade surplus at a time of extensive currency accumulation for foreign loan payments. The króna has depreciated as a result. There is considerable uncertainty about the persistence of these effects and therefore about near-term exchange rate developments. There is also the risk that self-fulfilling expectations of a depreciation will weaken the króna still further. In view of these conditions, the Central Bank has decided to suspend its program of regular foreign currency purchases for the time being and support the króna through foreign exchange intervention.

Although a slower rate of growth will ease inflationary pressures somewhat as the forecast horizon progresses, near-term inflation is projected to be higher than was forecast in November, owing to a weaker króna.

As spare capacity disappears from the economy, it is necessary that monetary policy slack should disappear as well. The degree to which such normalization takes place through higher nominal Central Bank rates will depend on future inflation developments, which in turn will depend on exchange rate movements and wage-setting decisions in the near future.

The monetary policy committee’s next scheduled rate announcement will be on March 20.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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