Wednesday, June 26, 2019

Iceland cuts rate 2nd time as economy seen shrinking

     Iceland's central bank lowered its benchmark policy rate for the second month in a row as a contraction in the economy is expected to become more obvious in coming months with the decline in tourism now seen deeper than previously expected.
      The Central Bank of Iceland (CBI) cut the rate on 7-day deposits by 25 basis points to 3.25 percent and has now cut it by 75 points this year following a cut in May when the outlook for the economy worsened sharply from a fall in tourism and a plunge in exports of marine products.
      Iceland's economy expanded by an annual 1.7 percent in the first quarter of the year, the slowest growth since the first quarter of 2014 and line with CBI's forecast from May when it slashed its outlook for 2019 output to a shrinkage of 0.4 percent from an earlier forecast of 1.8 percent growth and 2018's robust expansion of 4.6 percent.
      Although CBI said the latest economic data do not change its view of the expected slowdown, domestic demand could turn out to be more resilient than assumed but "the outlook is for the contraction in tourism to be deeper than previously expected."
      In May the central bank forecast tourist arrivals would drop 10.5 percent this year from 2018 due to the combination of a collapse of budget airline WOW, the impact of the strong krona, temporary strikes and uncertainty surrounding Icelandair's use of Boeing 737 Max jets.
      Inflation is also largely in line with the central bank's forecast that it has peaked and will decline toward the bank's target of 2.5 percent during the year though a further decline in the krona's exchange rate could change the outlook.
      "Inflation expectations have fallen since the MPC's last meeting, and the monetary stance has therefore tightened again," CBI said.
      Iceland's inflation rate eased to 3.3 percent in June from 3.6 percent in May.
      After rising steadily from early 2015 to mid-2017 on Iceland's economic boom, the krona has been dropping since April 2018 and was trading at 124.6 to the U.S. dollar today, down 6.6 percent so far this year.
      While the central bank acknowledged the economic contraction would present a challenge to both households and businesses, it said the economy was much more resilient than before and it has considerably more scope to respond to the weakening economy while proposals to ease fiscal policy will also pull in the same direction.


     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 3.75%. 
The most recent data on economic developments do not change the assessment of the economic outlook as presented to the Committee at its last meeting. GDP growth in Q1/2019 was in line with the Bank’s May forecast; furthermore, a contraction in the domestic economy is still anticipated and is expected to show more clearly in coming months. However, stronger private consumption in Q1 and leading indicators could imply that domestic demand has been more resilient than previously assumed. On the other hand, the outlook is for the contraction in tourism to be deeper than previously expected.
As yet, inflation has been in line with the Bank’s last forecast. According to that forecast, inflation has peaked and will ease back to target as the year progresses. Further depreciation of the króna could change these prospects, however. Inflation expectations have fallen since the MPC’s last meeting, and the monetary stance has therefore tightened again.
Although the economic contraction will be challenging for households and businesses, the economy is much more resilient than before. Furthermore, monetary policy has considerable scope to respond to the contraction, particularly if inflation and inflation expectations remain close to the target, as is currently envisioned. The proposed fiscal easing will pull in the same direction.
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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