23.06.2010

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

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 6.5% and the maximum bid rate for 28-day certificates of deposit (CDs) will be 7.75%. The seven-day collateralised lending rate will be 8% and the overnight lending rate 9.5%.

Since the last MPC meeting, the króna has appreciated by 5% in trade-weighted terms and 6% against the euro, or slightly more than assumed in the forecast published in the Monetary Bulletin in May. There has been no Central Bank intervention in the FX market. Furthermore, Icelandic sovereign risk premia have fallen since the last MPC meeting. Capital controls, current account developments and the risk-adjusted interest rate differential with major currencies continue to support the króna.

In May, inflation declined to 7.5% year-on-year, or 6.1% excluding the impact of higher consumption taxes. This is broadly in line with the forecast published in May. As before, inflation excluding consumption tax effects is expected to reach the target early next year. National accounts for Q1 2010 and other recent data do not fundamentally change the picture outlined in the May forecast.

Continued easing of monetary policy at this stage is justified by the appreciation of the króna and lower external risk premia, driven by better fundamentals and improved access to foreign liquidity through multilateral and bilateral agreements. These developments should facilitate the eventual removal of capital controls. The first steps towards complete liberalisation of the capital account could be taken relatively soon after the Third Review of the IMF-supported programme is completed.

Over time, the Central Bank will have to replace borrowed reserves with non-borrowed reserves. The appreciating króna and lower external risk premia could allow modest regular purchases of foreign currency. The timing and quantity of such purchases will be conducted so as to minimise the effect on the króna. No decisions on such purchases will be taken before the August MPC meeting.

The MPC’s room for manoeuvre is limited by remaining uncertainty concerning Iceland’s medium-term access to global financial markets and the prospect of capital account liberalisation. The additional uncertainty caused by the recent Supreme Court ruling on the legality of FX-linked loans could, if not resolved promptly, undermine confidence and further constrain monetary policy.

As before, if the króna remains stable or appreciates, and if inflation develops as forecast, there should be some scope for continued gradual monetary easing. The MPC stands ready to adjust its monetary policy 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.19/2010
23 June 2010

Back