Iceland maintains rate as economic boom slows fast

      Iceland's central bank kept its key rate on 7-day deposits at 4.25 percent, as it had flagged last month, saying the current stance "appears sufficient at present to keep inflation broadly at target" amid easing demand pressures and an improved inflation outlook.
      The Central Bank of Iceland (CBI) has cut its rate three times this year by a total of 75 basis points, with the most recent cut in October when it also said the rate was now sufficient to keep inflation broadly at the target.
       Although there are still "significant demand pressures," which call for a tight monetary stance to keep inflation under control, Iceland's booming economy is slowing faster than expected and the CBI lowered its outlook for growth this year sharply.
       The extraordinary boom in Iceland's tourism industry, the main source of export growth in the past two years, is now easing, while exports of marine products and silicon are also growing slower than expected and seen slowing further in the next few years.
       Although residential investment is still growing fast, it is now less than expected while house price inflation is also easing, helping curb inflation.
        The CBI now expects Iceland's economy to expand by 3.7 percent this year, down from 5.2 percent forecast in August and below 2016's 7.4 percent. Residential investment is seen expanding by 23.7 percent this year, down from 29.4 percent last year and 25.3 percent previously forecast.
       For 2018 the CBI is still expecting overall economic growth of 3.4 percent, up from 3.3 percent previously forecast, but growth is then seen easing toward the long-term growth trend of around 2.5 percent in 2019 and 2020.
       In the second quarter of this year Iceland's economy grew by an annual rate of 3.4 percent, down from 5.2 percent in the first quarter and over 10 percent in the previous two quarters, partly affected by a strike by fishermen that hit exports and inventories.
       With demand pressures easing and the Icelandic krona still strong, inflation remains under control although there are diminishing effects from the strong krona, the CBI said.
       This year inflation is seen averaging an unchanged 1.8 percent before rising to 2.5 percent next year, down from 2.6 percent forecast in August, and 2.3 percent in 2019, down from 2.8 percent. For 2020 inflation is seen at 2.8 percent, slightly above the CBI's 2.50 percent target.
       "Inflation expectations are well in line with the target, and fluctuations in the exchange rate during the year have had limited impact on inflation and inflation expectations," CBI said.
       Iceland's inflation rate rose to 1.9 percent in October from 1.4 percent in September while the exchange rate of the krona has been relatively stable since July. The krona was trading at 103.5 to the U.S. dollar today, up 9.1 percent this year.

     
   
        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 4.25%. 

According to the Central Bank’s new macroeconomic forecast, published in Monetary Bulletin 2017/4, GDP growth will slow significantly this year, and more than the Bank projected in August. It is forecast at 3.7%, down from last year’s GDP growth rate of 7.4%, as a result of a slowdown in export growth, after several strong years, and a pickup in import growth. 

The outlook is for inflation to align with the target in mid-2018 and stay close to target for the remainder of the forecast horizon. House price inflation has eased, which will contribute to lower headline inflation if the trend continues. Counteracting this are the diminishing effects of a strong króna. The króna has appreciated since the last MPC meeting, and exchange rate volatility has eased in recent months. Inflation expectations are well in line with the target, and fluctuations in the exchange rate during the year have had limited impact on inflation and inflation expectations. 

There are indications that the output gap may have peaked. Significant demand pressures remain, however, which calls for a tight monetary stance so as to ensure medium-term price stability. Reduced demand pressures and an improved inflation outlook are consistent with the MPC’s expectations in October, and the Bank’s real rate is broadly as it was after the October interest rate decision. The current monetary stance appears sufficient at present to keep inflation broadly at target. Whether this turns out to be the case in the coming term will depend on economic developments, including fiscal policy and the results of wage settlements.

The Bank’s interest rates will therefore be: 

1. Overnight loan: 6.00%
2. 7 day collateralised lending rates: 5.00%
3. Seven-day term deposit: 4.25%
4. Current accounts: 4.00%
5. Minimum required reserves:  4.00%"

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