Smaller Rate Cut in Iceland

February 2, 2011

Sedlabanki’s seven-day key lending rate was reduced to 4.25% from 4.5%.  The marginal lending rate, 28-day CD rate, and deposit rate were each also sliced by 25 basis points to 5.25%, 4.0%, and 3.25% respectively.  These were the smallest reductions of fifteen adjustments made since March 2009.  An IMF-mandate hike of three percentage pints in October 2008 had left the seven-day lending rate at 18%.  Six cuts in 2009 reduced such by 800 basis points to 10%.  Eight more cuts in 2010 totaled 575 basis points.  None of those was less than 50 bps in size, and the last one on December 8 totaled 100 basis points.

The central bank has been able to reduce its interest rates progressively because of falling inflation, lower expected inflation, slow economic growth, and a firm krona.  CPI inflation as of January was 1.8% and 1.6% excluding the effects of a consumption tax hike.  The headline CPI was down from 2.5% in December, 3.3% in October and 8.3% in April.  Officials target inflation at 2.5% in the medium term and project that goal will be met throughout their forecast period even as GDP growth hovers near 3%.  The next policy meetings are scheduled for March 16, April 20, and June 15.

A new statement released by Sedlabanki today justifies the smaller size of its cut in interest rates by several factors.  First, rates are now at historically low levels.  Second, the krona fell 4.5% in trade-weighted terms since the December meeting, and krona stability remains an interim goal that must be met to secure the broader need for price stability in the medium term.  Third, the planned removal of capital controls “creates uncertainty about the short-term room for maneuver” in monetary policy.  The statement concludes that “the direction of future policy moves has become more uncertain.”

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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