10 December 2009

Statement of the Central Bank of Iceland Monetary Policy Committee: Gradual monetary easing continues

The Monetary Policy Committee (MPC) has voted to change Central Bank interest rates as follows. The deposit rate (current account rate) will be lowered by 0.5 percentage points to 8.5%. The Central Bank will continue to issue 28-day certificates of deposit (CDs) with a maximum bid rate of 9.75%, which is 0.5 percentage points lower than before. The seven-day collateral lending rate will be lowered by 1 percentage point to 10%, and the overnight lending rate will be lowered by 1.5 percentage points to 11.5%.

In its 5 November statement, the MPC concluded that, if the króna remained stable or appreciated and if inflation continued to fall as forecast, conditions for further monetary easing would soon be in place. The current decision entails some monetary easing, in line with the November statement, and further aligns the Central Bank interest rate corridor with the effective monetary policy stance.
Auctions of 28-day CDs have been successful in draining liquidity from the market. In future, the MPC will decide only the maximum bid rate for the CD auctions in the coming period. On the basis of its liquidity forecast, the Central Bank will then announce the amount of CDs to be auctioned one business day in advance of each auction.

The króna has remained broadly stable since the last MPC meeting, with limited intervention by the Central Bank and no intervention at all since early November. Tighter regulation, enhanced surveillance, and more effective enforcement have made circumvention of the capital controls more difficult. In spite of improved external conditions, significant uncertainty remains concerning short-term capital flows. Foreign exchange intervention policy is intended to smooth out the short-term volatility this could bring to the foreign exchange market.

Inflation continued to decline in November, broadly in line with the latest forecast, measuring 8.6% year-on-year, or 7.7% excluding the impact of higher consumption taxes. The MPC's view is that the risk of second-round effects on inflation is limited and that inflation is driven primarily by exchange rate movements; thus the pace of disinflation will depend mostly on near-term exchange rate movements. If the króna remains stable or appreciates, and if inflation continues to fall as forecast, there should be scope for continued gradual monetary easing. As always, 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.