Icelandic Monetary Policy Rate Remains Paused

June 11, 2014

The last six changes in Sedlabanki’s 7-day collateralized lending rate were all increases, but the last of these occurred nineteen months ago on November 14, 2012.  A 25-basis point hike announced that day followed similarly-sized hikes in June and March of 2012 and August and November of 2011.  There was also a 50-basis point tightening done in May 2012.  Previously between November 2009 and February 2011, fifteen cuts 1,375 basis points were undertaken.

Early this year, monetary officials allowed for the possibility of that a near-term rate cut might become necessary because of lower-than-expected inflation but stuck to the view that resumed tightening would happen in the longer run.  A statement after the policy meeting in March said, “for the short term…..whether there is scope for a nominal interest rate reduction will depend on developments in inflation and inflation expectations in coming months.”  This possibility has now apparently disappeared.  There is no mention in today’s latest statement from Iceland’s Monetary Policy Committee of any chance of a rate reduction.

The choice now confronting policymakers centers upon how much longer they will be able to postpone the resumption of the aforementioned tightening cycle that began in November 2011.

Because of the decline in inflation and inflation expectations, the Bank’s real rate has risen markedly year-to-date. As a result, the slack in the monetary policy stance has probably disappeared. The level of the Bank’s neutral real rate is uncertain, but increased growth in domestic demand in the near term will probably require further increases in the Bank’s real interest rate, other things being equal. Whether this requires a change in the Bank’s nominal interest rates in the near future will depend on developments in inflation and inflation expectations.

Today’s statement also observes that 1) domestic demand expanded more rapidly last quarter than assumed, 2) production, however, grew less strongly than forecast, 3) currency intervention by the Central Bank of Iceland continues to constructively promote price stability, 4) long-term expected inflation still lies somewhat above target even though short-term inflation expectations have fallen, and 5) actual inflation will probably hover near target over the coming two years.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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