Back-to-Back Icelandic Interest Rate Cuts

December 10, 2014

Sedlabanki’s Monetary Policy Committee has followed up November’s 25-basis point cut with a greater-than-forecast 50-bp reduction in Iceland’s seven-day lending rate to 5.25%, which is the lowest level in 2-1/2 years.  A released statement justifies the action by lower inflation than forecast and signs that expected inflation has fallen, too.  More cuts are not ruled outThe upcoming wage round will be a key determinant of future monetary policy actions.

The outlook for the near term is for lower inflation than was expected at the time of the November interest rate decision. Inflation is therefore likely to be markedly below target at least through mid-2015. Inflation expectations have fallen as well in recent months and, by most measures, are now close to target.  In spite of the nominal interest rate reduction in November, the Bank’s real rate has risen further, owing to the significant decline in inflation and inflation expectations, and is higher than is warranted by the business cycle position and the near-term outlook.

Although the inflation target is 2-3%, the latest total 12-month rise of the CPI was 1.0%, and such would have been below zero if housing components are not included.  From March 2009 through February 2011, fifteen rate reductions slashed the one-week lending rate to 4.25% from 18.0%.  Six increases (five of 25 bps and one of 50 bps) followed between August 2011 and November 2012.  GDP growth was softer last quarter, but other measures of domestic demand point to a solid outlook.

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



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