Wednesday, February 5, 2020

Iceland cuts rate 6th time, economic outlook deteriorates

     Iceland's central bank returned to the easing path and cut its key interest rates by another 25 basis points as the outlook for 2020 and 2021 has deteriorated, with the forecast for both economic growth and inflation lowered.
     The Central Bank of Iceland (CBI) cut its benchmark 7-day deposit rate for the 6th time to 2.75 percent and has now cut it by 175 basis points since May 2019.
     In December, however, CBI left its rate unchanged, signaling a pause in the easing.
     But with inflation lower than expected and corporate credit spreads higher, CBI's monetary stance has tightened. Inflation expectations also remain anchored to CBI's target, a development that gives it "scope to respond to the deteriorating economic outlook."
     As in December, CBI said near-term monetary policy will depend on the interaction between economic activity, inflation and inflation expectations.
     Iceland's economy experienced a sharp shock in 2019 as its tourism industry was hit by the collapse of budget airline WOW, the grounding of Icelandair's Boeing Max 737 aircraft and the continued impact of the high exchange rate of the krona. On top of this, Iceland's exports were hit by the failure of the capelin catch due to rising ocean temperatures.
     In the first three quarters of 2019 the economy expanded by only 0.2 percent but then bounced back more than expected in the fourth quarter so growth for the full year is estimated at 0.6 percent, better than the November forecast of a 0.2 percent shrinkage.
     But the outlook for this year and next year have worsened, as goods and services exports are set to contract this year instead of grow due to a slower recovery of tourism, production difficulties in the aluminum industry and the second consecutive failure of the capelin catch.
    In addition, the spread on corporate credit rates rose in late 2019, leading to a sharp downward revision of business investments in 2020 and 2021.
    Growth in 2020 is now forecast at 0.8 percent, down from November's forecast of 1.6 percent, and then 2.4 percent in 2021, down from 2.9 percent. In 2022 growth is seen of 2.6 percent.
     Inflation decelerated rapidly in the second half of last year - but still averaged 3.0 percent - and continued to fall to 1.7 percent in January, below CBI's target of 2.5 percent.
     In its February bulletin, CBI sees inflation below its target for the next two years, and the forecast for consumer price inflation in 2020 was cut to 1.9 percent from an earlier 2.3 percent and the 2021 forecast to 2.1 percent from 2.2 percent. For 2022 inflation is seen at 2.2 percent.
     Iceland's krona rose steadily from March 2015 to April 2018 but then eased until July 2019.
    Since then krona has remained more stable though it dipped after the rate cut to trade at 125.3 to the U.S. dollar today, down 3.3 percent this year.

    The Central Bank of Iceland issued the following press release:

"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 2.75%.
Leading indicators suggest that GDP growth was stronger in 2019 than previously assumed, while the outlook for 2020 and 2021 has deteriorated, according to the Bank’s new macroeconomic forecast, published in the February Monetary Bulletin. According to the new forecast, GDP growth will measure only 0.8% this year, compared to 1.6% in the November forecast. The poorer outlook is due primarily to headwinds facing the export sector and tighter financing conditions for domestic firms.
Inflation declined rapidly over the course of 2019 and aligned with the target in Q4. It continued to fall in January, measuring 1.7%, the lowest observed inflation rate since autumn 2017. Underlying inflation has also fallen and is now at target, as are most measures of inflation expectations.

According to the Bank’s new forecast, inflation will be lower than was projected in November and below the target for most of the forecast horizon.
The monetary stance as measured in terms of the Bank’s real rate has therefore tightened somewhat since the MPC’s last meeting. The rise in corporate credit spreads has tightened the monetary stance even further.
Because inflation expectations are more firmly anchored to the target than before, monetary policy has had the scope to respond to the deteriorating economic outlook. The task of monetary policy is to secure medium-term price stability, but also to use the scope that it has to support a normal level of capacity utilisation.
Near-term monetary policy decisions will depend on the interaction between developments in economic activity, on the one hand, and inflation and inflation expectations, on the other."


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