22.09.2010

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

The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to lower the Bank’s interest rates by 0.75 percentage points. The deposit rate (current account rate) will be 4.75%, and the maximum bid rate for 28-day certificates of deposit (CDs) will be 6.0%. The seven-day collateralised lending rate will be 6.25% and the overnight lending rate 7.75%.

Inflation continued to subside in August, after a marked decline since March. The CPI rose 4.5% year-on-year, or 3.8% excluding consumption tax effects. Weak economic activity and this year’s appreciation of the króna continue to support disinflation.

National accounts data for Q2/2010 indicate that demand and output are developing broadly in line with the Central Bank’s updated forecast from August, although weaker-than-expected investment might suggest that the contraction in 2010 will be closer to that forecast in May. However, recovery is still expected to begin in the second half of the year. The inflation outlook is also more or less unchanged since August. Inflation excluding tax effects is still expected to reach the Bank’s inflation target by year-end and to fall somewhat below the target early in 2011. Inflation expectations have also continued to decline.

Since the MPC’s August meeting, the króna has appreciated by roughly ½%, both in trade-weighted terms and against the euro. As expected, regular purchases of foreign currency by the Central Bank, which commenced on 31 August, appear not to have affected the stability of the króna. The capital controls, developments in terms of trade and other factors affecting the current account balance, and the monetary policy stance relative to trading partner countries all continue to support the exchange rate.

The Third Review of the Government-IMF economic programme is now likely to be completed by the end of September. Once completed, the prerequisites for the resumption of capital account liberalisation will be in place as regards the foreign exchange reserves and macroeconomic stability. Furthermore, uncertainty about the strength of the financial system has been significantly reduced by the recent Supreme Court judgment on the reference interest rate to be used in loan agreements with non-binding exchange rate linkage clauses. The conditions for removal of the capital controls are therefore closer to being met than they were in August, creating some short-term complications for monetary policy.

The Committee considers that, if the króna remains stable or appreciates and inflation subsides as forecast, the premises for some further monetary easing should be in place. However, the prospects of capital account liberalisation create uncertainty about short-term room for manoeuvre. 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. 28/2010
22 September 2010

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