Iceland's central bank cut its key interest rates for the 10th time in 18 months, saying the recent surge in COVID-19 cases and tighter public health measures had weakened the economic rebound that began in the summer, leading to a weaker outlook for economic growth this year and next year.
The Central Bank of Iceland (CBI) cut its benchmark seven-day deposit rate by another 25 basis points to 0.75 percent and has now cut it five times this year by a total of 225 basis points.
Since May 2019, when the outlook for the North Atlantic island darkened, the central bank has cut the rate 10 times and by a total of 375 basis points.
On Oct. 30 Iceland tightened its measures to combat the pandemic, suspending all sports activities and stage performances and limiting gatherings to 10 from 20 people. Some of these restrictions, including those on sports and leisure activities in schools, were eased on Nov. 18 and authorities expect to further relax its restrictions early December.
"The autumn surge in COVID-19 cases and the tightened public health measures have weakened the economic rebound that began in Q3, following a historically large contraction in Q2," CBI said.
Iceland's economy shrank for the second consecutive quarter in the second quarter of this year, with gross domestic product contracting by 9.1 percent following a 5.7 percent contraction in the first quarter.
In August, when the central bank paused in its monetary easing campaign, it raised its outlook for economic growth this year as household consumption had not declined as much as expected.
But in its October policy statement, the central bank's monetary policy committee (MPC) noticed growth in demand had begun to ease in late summer and the economic outlook had deteriorated relative to its quarterly forecast from August.
Today, in its November economic report, CBI slashed its outlook for 2020 growth this year as demand and exports were seen lower than in the August report, with GDP now seen shrinking 8.5 percent from an previously expected 7.1 percent decline.
"The economic outlook is highly uncertain, and economic developments will depend to a considerable degree on the path the pandemic takes," CBI said, reiterating its view from October.
The central bank's forecast for 2021 growth was lowered to 2.3 percent from an earlier 3.4 percent but in 2022 Iceland's economy is seen expanding by 5.7 percent and then 3.9 percent in 2023.
Iceland's economy slowed sharply in 2019 to growth of only 1.9 percent from 3.8 percent in 2018, hit by a series of adverse events, including a hit to tourism from the collapse of a budget airline and the grounding of Icelandair aircraft, the failure of the capelin catch due to rising ocean temperatures and production difficulties in the aluminum industry.
The Icelandic krona was largely unchanged after today's rate cut, trading at 136 to the U.S. dollar, down 10.8 percent since the start of this year and down 27 percent since highs around April 1, 2018.
After rising for three years from March 2015 to April 2018, the krona has been steadily declining and fell sharply in March this year, as most other currencies.
Iceland's inflation rate has risen for 7 months in a row - it rose to 3.6 percent from 2.1 percent in March - and is now higher than earlier expected but CBI said inflation expectations were largely unchanged and it expects inflation to average about 3.7 percent until early 2021 before easing due to the slack in the economy.
As in October, the central bank said "more firmly anchored inflation expectations provide the MPC (monetary policy committee) the scope to respond decisively to the deteriorating economic outlook," signaling it is ready to ease its policy stance further if needed, including bond purchases.
The Central Bank of Iceland issued the following statement:
"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 0.75%.
The autumn surge in COVID-19 cases and the tightened public health measures have weakened the economic rebound that began in Q3, following a historically large contraction in Q2. The economic outlook has therefore deteriorated, and according to the forecast in the November Monetary Bulletin, GDP growth is set to contract by 8.5% this year, a full 1 percentage point more than was forecast in August. GDP growth is projected to be weaker in 2021 as well. The economic outlook is highly uncertain, and economic developments will depend to a considerable degree on the path the pandemic takes.
The króna depreciated after the pandemic reached Iceland but has been relatively stable in the recent term. Inflation has risen since the spring, measuring 3.6% in October; however, medium- and long-term inflation expectations are broadly unchanged. According to the Bank’s forecast, the outlook is for inflation to average about 3.7% until early 2021 and then begin to ease, owing to the sizeable slack in the economy.
Although inflation has risen temporarily and appears set to be higher than was assumed in August, more firmly anchored inflation expectations provide the MPC the scope to respond decisively to the deteriorating economic outlook. Interest rate reductions and other measures taken by the Central Bank in the past few months have supported domestic demand and mitigated the adverse impact of the economic shock.
The MPC will continue to use the tools at its disposal, including Treasury bond purchases by the Central Bank, to support the domestic economy and ensure that the more accommodative monetary stance is transmitted normally to households and businesses."
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