The Central Bank of Iceland held its policy rates steady and eased up on its previous warnings about the need for rate hikes to curb inflation, saying short-term expectations for inflation had declined while long-term expectations still remain well above the bank’s target.
“Because inflation is lower, the krona stronger, and wage increases smaller than was forecast in February, the medium-term inflation outlook has improved from previous estimates,” said the central bank, which kept its benchmark seven-day lending rate at 6.0 percent in 2013 after raising it by 125 basis points in 2012.
Iceland’s inflation rate eased to 2.1 percent in February from 3.1 percent in January, the lowest rate since February 2011. The bank said data showed that over the past two years, wage costs per man-year had risen considerably less than previous data had suggested and last year’s wage deals would apply to most of the labour market.
The central bank targets inflation of 2.5 percent and last month forecast that inflation in 2014 would average 2.7 percent, rising to 3.4 percent in 2015.
The central bank has been warning about the need for rate hikes for many months and in February it said that its policy stance could be tightened sooner than expected due to the outlook for growth.
The central bank has forecast Gross Domestic Product growth of 2.6 percent in 2014 and 3.7 percent in 2015 and the bank said the outlook for increased growth in demand will, other things being equal, call for an increase in the interest rates.
However, measures that support monetary policy, including medium-term fiscal policy, could offset this while improvements to the economy’s supply side could weaken the inflationary effects of increased demand.
“Whether there is scope for a nominal interest rate reduction will depend on developments in inflation and inflation expectations in coming months,” the bank said.
Further ahead, the bank said real interest rates “must be raised” if the expected outlook materializes but the extent of the increases would depend on inflation.
Iceland’s GDP expanded by 0.3 percent in the fourth quarter of 2013 from the third quarter for annual growth of 3.8 percent, down from 4.9 percent in the third quarter.
The Icelandic krona rose 10 percent in 2013 and has continued to rise this year. Against the U.S. dollar, the krona was trading at 112.85 today, up 2.7 percent this year.