18 September 2007

Inflation beyond the tolerance limit

At the beginning of September, the twelve-month rise in the consumer price index measured 4.2%. The inflation target is 2½%. The joint declaration by the Government of Iceland and Central Bank of Iceland from March 27, 2001 stipulates that if inflation moves by more than 1½% beyond the inflation target, the Bank is obliged to submit a report to the Government explaining the reasons for the deviation, how the Bank intends to react and how long it will take to reach the inflation target again in the Bank’s assessment.

On Thursday, September 6, the Board of Governors of the Central Bank of Iceland announced that its policy interest rate would be left unchanged at 13.3%. A press release announcing the decision stated that the inflation forecast published in Monetary Bulletin in July this year implied that a reduction in the policy rate would not be possible until the first half of 2008.

In the view of the Board of Governors, there were no grounds for departing from that assessment at present. Furthermore, the exchange rate of the króna had been volatile recently and the short-term inflation outlook had deteriorated somewhat since the last interest rate decision was announced. Long-term prospects were unchanged, however, and the analysis of the long-term inflation outlook published in Monetary Bulletin in July still broadly held.

According to the baseline forecast published in Monetary Bulletin in July this year, inflation would slow down and move close to target after the middle of 2008, then attain it in 2009. The latest rise in the CPI, along with new national accounts data, indicates that inflation pressures are stronger than had been expected.

In March 2007, the Central Bank began publishing its own projection for the policy interest rate path. This implies that, in effect, the questions raised in the declaration by the Government and the Central Bank from 2001 are now answered in each edition of Monetary Bulletin. The Central Bank will publish a new macroeconomic and inflation forecast in Monetary Bulletin on November 1. The Board of Governors’ next interest rate decision will be announced at the same time.

In light of the above, and with the consent of the Prime Minister of Iceland, the Board of Governors does not consider that publication of a detailed report is warranted at present. The rise in measured inflation to 4.2% now is a temporary deviation along the disinflationary path outlined in the Bank’s July forecast.

No. 18/2007
September 18, 2007