Statement of the Central Bank of Iceland Monetary Policy Committee: Central Bank rates lowered

The Monetary Policy Committee (MPC) has voted to lower Central Bank interest rates by 0.5 percentage points. The deposit rate (current account rate) will be lowered to 7.5%. The maximum bid rate for 28-day certificates of deposit (CDs) will be 8.75%. The seven-day collateral lending rate will be 9% and the overnight lending rate 10.5%.

Supporting an interest rate cut is the appreciation of the króna in trade-weighted terms since the last MPC meeting, despite the absence of Central Bank intervention in the FX market. This development, in an external environment of elevated sovereign risk premia and continued uncertainty about Iceland’s medium-term access to global financial markets, reflects the effectiveness of the capital controls and more favourable current account developments.

Inflation picked up in February, after a decline in December and January, to 7.3% year-on-year, or 5.9% excluding the impact of higher consumption taxes. The pick-up in inflation was broadly anticipated and does not fundamentally change the conclusion of the January forecast. Inflation is assumed to rise further year-on-year in March due to unfavourable base effects, but underlying inflation is still expected to reach the target late this year.

Elevated CDS spreads and a negative rating outlook associated with uncertainty about Iceland’s access to global financial markets support a relatively cautious move, due to potential negative pressure on the króna going forward. The delay in resolving the dispute over compensation of depositors in foreign branches of Landsbanki has triggered a sovereign credit rating downgrade to non-investment grade by one of the rating agencies and continues to delay the Second Review of the IMF programme and the associated financing. Given the continued effectiveness of the capital controls, this is not expected to have a substantial immediate effect on the exchange rate. However, in the absence of multilateral and bilateral financing or full access to international capital markets on acceptable terms, removal of capital controls or sizeable interest rate cuts would be risky until this matter is resolved.

If the króna remains stable or appreciates, and if inflation develops as forecast, there should be scope for continued gradual monetary easing. However, as long as there is significant uncertainty about Iceland’s future access to international capital markets, the MPC will have limited room for manoeuvre. As always, the MPC stands ready to adjust the monetary stance as required to achieve its interim objective of exchange rate stability and ensure that inflation is close to target over the medium term.

No. 5/2010
17 March 2010