Iceland's central bank left its key policy rate, the seven-day deposit rate, at 5.75 percent, but repeated its view that "a tighter monetary stance will probably be needed in the coming term, in view of growing domestic inflationary pressures."
However, the Central Bank of Iceland (CBI) also said that "global price developments and a stronger krona have provided scope to raise interest rates more slowly than was previously considered necessary" and there were signs that inflation expectations had been anchored more securely than before, contributing to a more moderate rise in inflation than would have been expected given large pay increases.
Last year the CBI raised its policy rate by 125 basis points to curb inflationary pressure but in its latest monetary bulletin, the central bank lowered its forecast for inflation this year to 2.1 percent from February's forecast of 2.3 percent while the forecast for 2017 inflation was unchanged at 4.1 percent and the 2018 forecast was raised to 3.8 percent from 3.4 percent as economic growth is now seen to be higher than earlier forecast.
"How much and how quickly the monetary stance must be tightened will depend on future developments," said the CBI, which targets inflation of 2.5 percent.
Despite large pay rises and a positive output gap, Iceland's inflation rate has been below the bank's target for over two years and in April it rose to 1.6 percent from 1.5 percent in March as domestic inflationary pressure was offset by the strong exchange rate of the krona and "usually" low global inflation.
The central bank revised upwards its forecast for economic growth to 4.5 percent this year from 4.2 percent following growth of 4.0 percent last year.
Gross Domestic Product in 2017 is seen expanding by 4.0 percent, up from 3.4 percent previously forecast, and by 3.0 percent in 2018, up from 2.9 percent as domestic demand as the unemployment rate falls to 3.3 percent this year, 3.2 percent in 2017 and 3.4 percent in 2018.
After losing about half its value during the global financial crises, Iceland's krona has appreciated steadily since March 2015 and rose further today, trading at 122.7 to the U.S. dollar, up 5.8 percent since the beginning of this year.
The Central Bank of Iceland issued the following statement: