24 September 2009

Statement of the Central Bank of Iceland Monetary Policy Committee: Unchanged monetary policy stance

The Monetary Policy Committee (MPC) has voted to keep the monetary stance unchanged. More precisely, the MPC has decided to keep the collateral loan and deposit rates unchanged at 12% and 9.5%, respectively. However, the Committee has decided to auction 28-day certificates of deposit (CDs) with a minimum bid rate of 9.5% and a maximum of 10%. In addition, the MPC has decided to cut the overnight lending rate from 16% to 14.5%.

Since April 2009, the effective Central Bank rate that governs other short-term interest rates - such as money market and bank deposit rates - has been the Bank's deposit rate, as the banking system has had ample liquidity and has not been borrowing from the Bank. As is previously stated, this rate is currently 9.5%. However, there are indications of excess liquidity in the system at this rate; hence the decision to auction CDs.

The króna has remained broadly stable since the last monetary policy decision on August 13, in spite of a significantly lower level of Central Bank foreign exchange intervention. Foreign exchange market turnover has increased. The króna continues to be weak, however, dampening the disinflation process. Nevertheless, inflation is expected to resume a strong downward trend later this year due to the slack in the economy, thus reducing the risk of significant second-round effects.

There are some encouraging signs. Along with the decreasing need for foreign exchange intervention, the trade surplus has turned out somewhat larger than expected. The business sector's accumulation of foreign exchange deposits at domestic banks has stopped. Export prices have firmed. Moreover, the risk premium on króna-denominated assets continues to decline, as is reflected, for instance, in CDS spreads.

Leakage of the capital controls has been a continuing cause for concern and has contributed to the persistent weakness of the króna. Consequently, the Central Bank has taken steps to strengthen surveillance and enforcement of the controls, in addition to providing sufficient returns on króna assets.

Conditions for the phased removal of the capital controls might soon be in place, provided that bilateral and multilateral financing is secured. Other conditions include continued Government commitment to a sustainable medium-term fiscal plan and well-advanced financial sector restructuring. Broadly speaking, these goals have been met. In this connection, it should be emphasised that the First Review of the IMF Stand-by Agreement will be an important stepping stone for restoring confidence and is a prerequisite for a successful liberalisation of the capital controls. During the transition period, monetary policy will be guided by the interim objective of stabilising the króna.

No. 32/2009

September 24, 2009