18 September 2002

The Central Bank of Iceland lowers interest rates

The Board of Governors of the Central Bank of Iceland has decided to lower the yield in the Bank's repurchase transactions with credit institutions by 0.5 percentage points to 7.1 percent, effective at the next auction of repurchase contracts on September 24, 2002.

When the Central Bank of Iceland published its inflation forecast and assessment of the economic situation and prospects on August 1, it lowered the interest rate in repurchase transactions by 0.6 percentage points. That decision was motivated by a rapidly declining rate of inflation, growing economic slack and increased prospects that the inflation target of the Bank would be achieved before the end of the year. Furthermore, the Bank indicated that it would lower its interest rates further in the period ahead if developments substantiated these prospects. A significant fall in the consumer price index in August and indications that the recovery of domestic demand was slow and well below what was needed to prevent further economic slack prompted the Central Bank to lower its policy rate by 0.3 percentage points on September 1.

The rise in the consumer price index in September was at the upper end of the range of market expectations. Nevertheless, price developments in the last two months conform fully to the inflation forecast of the Central Bank from August 1. Moreover, new figures indicate a growing slack in the labour market. There are also indications that economic growth in the coming year will be slower than forecast by the National Economic Institute in June of this year such that the output gap would grow further. The reasons for this are that global economic prospects have deteriorated and that it is becoming unlikely that domestic business investment will grow in 2003 on the scale entailed in the forecast of The National Economic Institute in June. However, that could change if a decision is taken on a new power intensive manufacturing project and related investment. 

This is the background to the Central Bank's decision to lower its policy rate now. The Bank will lower its policy rate further if developments in the coming weeks confirm even more firmly the rapid decline in the rate of inflation towards the inflation target of the Bank and a growing slack in the economy.

September 18, 2002