Icelandic Monetary Policy Pause Nearly Over

October 3, 2012

The 5.75% seven-day collateralized lending rate was left unchanged after the Monetary Policy Committee met at the Central Bank of Iceland (Sedlabanki), but a released statement warned, “in the absence of changes in the outlook for inflation and the economic recovery, it is likely that further interest rate increases will be needed in the near future (italics added).”  From a low of 4.25% prevailing from February 2011 until August 2011, five previous increases were administered.  Four of those moves were by 25 bps in August and November 2011 as well as March and June of 2012, and the other move’s size in May 2012 was 50 basis points.  To preserve price stability, rate normalization is needed as spare capacity in the economy declines.  The tightening pause in August and this month was possible because domestic demand has grown more slowly than assumed and due to somewhat lower inflation, which boosted real interest rates.  But three other points made in the statement — a recent weaker krona tone, lessening financial market risks, and above-target expected inflation — are consistent with further increases in the key central bank lending rate.  From March 2009 to February 2011, that interest rate was lowered from 18% to 4.25% in a series of fifteen moves.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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