The Central Bank of Iceland (CBI), which raised its rate by 125 basis points in 2015, said global price developments and a stronger exchange rate of the krona had provided scope to raise rates more slowly than previously considered as it lowered its forecast for inflation and raised the forecast for economic growth.
In its latest monetary bulletin, the CBI forecast average consumer price inflation of 2.3 percent in 2016, sharply down from 3.3 percent seen in November, and 4.1 percent inflation for 2017, down from 4.0 percent, but an unchanged 3.4 percent inflation rate for 2018.
Iceland's inflation rate rose to 2.1 percent in January from average 2015 inflation of 1.6 percent as the margin of spare capacity in Iceland's economy was estimated to have disappeared last year and is expected to widen even further.
"Pay rises well in excess of the inflation target and productivity growth exacerbate inflationary pressure, which are offset by developments in global energy and commodity prices and the exchange rate of the krona," the central bank said.
Unlike most other currencies worldwide, the Icelandic krona has been appreciating against the U.S. dollar since March 2015 and was trading at 126.8 to the dollar today, up 2.4 percent since the start of this year but only up 0.5 percent since the start of 2015.
The CBI, which targets inflation of 2.5 percent, said the trend of deflation in global goods markets could come to a halt later this year, which would push up inflation though the extent and timing of changes to global prices was uncertain.
Economic growth in Iceland last year was estimated at 4.1 percent, weaker than the central bank's forecast of 4.6 percent, but growth this year is forecast to rise slightly to 4.2 percent, sharply up from the November forecast of 3.2 percent, as private consumption is expected to rise, pulling up wages, employment and inflation.
The CBI forecast a 5.3 percent rise in private consumption this year, up from 4.9 percent in 2015, before easing to growth of 4.2 percent in 2017 and 3.4 percent in 2018.
The CBI left its key rate, the seven-day deposit rate, unchanged at 5.75 percent and the seven-day lending rate at 6.25 percent.
The Central Bank of Iceland issued the following statement:
"The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to keep the Bank’s interest rates unchanged. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore remain 5.75%.