Statement of the Monetary Policy Committee 14 December 2016
The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to lower the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 5%.
The national accounts for the first nine months of the year show stronger GDP growth than the Central Bank forecast in November. Growth in domestic demand was broadly in line with that forecast, but its composition was different: business investment growth was stronger than projected, while private consumption growth was weaker. Export growth was also stronger than had been forecast, mainly due to robust services exports. The current account balance showed a record surplus in the third quarter of the year.
Inflation measured 2.1% in November and has remained below target for nearly three years despite large pay increases and rapid demand growth. This is due largely to favourable external conditions and the appreciation of the króna but also to a tight monetary stance, which has anchored inflation expectations.
The MPC’s decision to lower interest rates reflects the Central Bank’s last forecast and more recent information. The exchange rate has risen by 1½% since the Committee’s last meeting and is already above the projected average for 2017. In addition, the composition of GDP growth is more favourable than was forecast in November, in that exports and business investment weigh more heavily than previously projected. Both of these factors affect the Committee’s risk assessment. As before, there is considerable uncertainty about the fiscal stance, which has eased in the past two years and still remains uncertain because it is unclear at present what the next Government’s economic policy will be. As in November, there is unrest in the labour market and uncertainty about the impact of upcoming steps towards capital account liberalisation.
Inflation expectations appear more firmly anchored to the target than before, and the monetary stance has tightened to some extent, through the appreciation of the króna. This gives the MPC some scope to lower nominal interest rates now. Nevertheless, strong demand growth and the aforementioned uncertainties call for caution in interest rate setting. The monetary stance in the coming term will be determined by economic developments and actions taken in other policy spheres.
14 December 2016