Central Bank of Iceland Shifts Gears

June 10, 2015

First some policy history.  Iceland’s seven-day collateral lending rate was slashed in 15 steps to 4.25% by February 2011 from 18.00% prior to March 2009.  Then, seven increased between August 2011 and end-2012 lifted the rate back to 6.0%.  The next directional reversal came late last year, cuts of 25 basis points in November followed by 50 bps in December. 

Now monetary officials are most unhappy with a deterioration of the outlook for inflation.  Although inflation remains below the 2.5% target, the main interest rate today was lifted 50 basis points to 5.75%, thus reversing last December’s cut.  While a hike was anticipated, analysts were expecting the size to be 25 basis points.  More importantly, the language of today’s statement is forcefully hawkish, essentially promising another increase at the next meeting in August and warning that even more moves beyond then:  “it seems apparent that a sizeable rate increase will be necessary in August, followed by further rate hikes in the coming term, so as to ensure price stability over the medium term.”  The statement cites several factors for its latest policy reversal:

  • Wage demands and awards in Iceland have been running “significantly” above levels assumed by officials.
  • Iceland’s government plans to dismantle capital controls imposed in 2008.
  • Measures of expected inflation are rising.
  • Fiscal policy has been loosened.
  • Domestic demand grew by almost 10% last quarter.
  • Fear that hard-won disinflation could be undone by the above developments if not checked by tighter monetary policy.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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