Icelandic Monetary Policy Tightened

November 14, 2012

A further 25-basis point increase in Sedlabanki’s key interest rates — including the 7-day collateralized lending rate to 6.0% — represents the latest step in a rate normalization process that began fifteen months ago and has so far been administered in six steps.  The fifth move was also by 25 basis points and occurred in June.  In total, rate have been lifted by 175 basis points after dropping 1375 bps from March 2009 through February 2011.  In a statement from Central Bank of Iceland officials, the context of today’s action is summarized as follows:

The accommodative monetary stance has supported the economic recovery in the recent term. The rise in interest rates since August 2011 and the decline in inflation have withdrawn a considerable amount of that accommodation. 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. The current baseline forecast indicates that the Bank’s present nominal interest rate is sufficient to bring inflation back to the inflation target during the forecast horizon. However, this depends, among other things, on whether the outcome of the forthcoming wage settlement review at the beginning of next year is consistent with inflation declining to the target.

Today’s statement observes that the broad outlooks for growth and inflation over the 2012-14 forecast period are not different from those assumed in the August economic review.  However, economic slack is likely to disappear within the forecast period.  Prior krona weakness could be another source of upward price pressure.  Although expected inflation has moved a bit lower, such still exceeds the central bank target.  As noted in the final line of the above quote, future policy will hinge in no small part on the evolution of wage awards in Iceland.  Iceland’s inflation target is a 2.5% 12-month increase in consumer prices.

The next interest rate announcement is scheduled for December 12.

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



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