Icelandic Financial Market Digest 16. maíPublisher: Íslandsbanki Research • Resp.Editor: Ingólfur Bender
How much will the recent ISK appreciation affect the MPC?
The ISK has appreciated by over 5% year-to-date, much more than over the same period in 2016, despite the liberalisation of capital controls and the fishermen's strike in the early months of this year. The exchange rate has also been more volatile year-to-date than in recent years. This could pose something of a problem for the Central Bank (CBI) Monetary Policy Committee (MPC) as it attempts to interpret the impact of exchange rate developments on the CBI's short-term interest rate policy, as the exchange rate appears to have been a major factor in the MPC's decisions in recent years.
Tailwinds behind the ISK last week
The ISK appreciated markedly last week, following an episode of calm at the beginning of May. It strengthened by 1.9% against the euro and 1.3% against the US dollar. The pace of the appreciation picked up as the week passed, and it is not unlikely that the Central Bank (CBI) intervened in the market later in the week in a bid to slow it down. If so, this would be the bank’s first intervention since 25 April, apart from its regular foreign currency purchase. Turnover in the interbank market averaged EUR 7m per day in the first third of May, well below the daily average of EUR 19m over the first third of the year. Turnover was therefore limited until 10 May, while figures for the latter half of last week have not yet been released.
Swifter appreciation, increased volatility
There are a number of possible explanations for these recent developments. The stream of tourists coming to the country is growing week by week, and FX flows relating to marine product exports are probably in better balance now than in the early months of the year. In addition, exporters must pay public levies at mid-month, and this often causes an uptick in inflows during the days leading up to the deadline. And finally, there are signs that non-residents are stepping up their investments in domestic firms. It is possible, for example, that a portion of last week’s inflows were related to Eyrir Invest’s sale of 10m shares in Marel for just under ISK 3.5bn. Earlier this year, Eyrir sold ISK 4.3bn worth of Marel shares to a foreign investor.
As of 12 May, the ISK had appreciated by just over 5.3% year-to-date in trade-weighted terms. This is substantially more than over the same period in 2016, when the appreciation through 12 May was about 1.8%. On the other hand, volatility has been considerably greater this year than in 2016, both in terms of day-to-day movements and within individual months. Liberalisation of the capital controls plays a key role here, as it is now much easier for residents and non-residents alike to buy and sell ISK than it was last year.
Exchange rate developments a major factor in CBI interest rates
The CBI’s Monetary Policy Committee (MPC) has lowered the policy rate four times during the current upward cycle. The first two rate cuts took place late in 2014. The MPC lowered the policy rate by 0.25 in November of that year and then followed with a 0.5-point rate cut in December. Inflation was 1% at the time, and newly published indicators suggested weak GDP growth. The policy rate was the same then as it is now, and the real policy rate was about 0.9 percentage points higher. There was a slack in the economy at that time, and seasonally adjusted unemployment was 5.6%.
The latter two rate cuts took place in the second half of 2016. The first one, a rate reduction of 0.5 percentage points, took place in August 2016, when inflation measured 1.1% and the ISK had appreciated by 6.8% since the previous interest rate decision. The policy rate was 0.75 percentage points higher than it is now and the real policy rate more than 1.5 points above the current level. The output gap was narrower then.
The latter instance, a rate cut of 0.25 percentage points, took place in December. At that point, the ISK had appreciated by nearly 6% since the MPC’s October meeting and over 9% since the August rate reduction. The MPC was of the opinion that the inflation outlook had improved because of exchange rate developments. Inflation measured 2.1%, the real policy rate was close to the current level, and the output gap was narrower.
It is clear that last year’s policy rate reductions were implemented largely because of developments in the exchange rate. The ISK appreciated by more than 18% over the course of the year, the largest single-year appreciation ever measured. This radically changed both the inflation outlook and actual developments in inflation. The exchange rate will also be a major factor in the MPC’s decisions in 2017. In this context, we expect the ISK to appreciate this summer and to play a leading role in the Committee’s decision to lower the policy rate this autumn. It will be interesting to see how big a part the past few days’ exchange rate movements will play in the MPC’s decision this Wednesday. It probably complicates matters somewhat that a fair portion of the ISK appreciation has taken place since the CBI completed its new macroeconomic and inflation forecast, which will be published on Wednesday and will form at least part of the basis for the MPC’s decision. We expect the MPC to hold the policy rate unchanged on Wednesday. However, the ISK has appreciated by 2.2% since we published our forecast, and this casts additional doubt on our projections. The MPC is conducting its meeting this week (Monday and Tuesday) and will announce its policy rate decision on Wednesday.
Icelanders’ payment card use abroad closing in on all-time high
According to payment card turnover figures published by the Central Bank of Iceland (CBI) on Friday, Icelanders’ payment card use abroad soared in April, rising in ISK terms to one of the highest levels ever recorded, second only to June 2016, the peak of the UEFA football frenzy. After adjusting for exchange rate developments in the interim, however, the April 2017 total is the largest ever measured. This comes as no surprise, as it is consistent with the surge in overseas travel in April and Icelanders’ growing penchant for shopping abroad. But in spite of this, the payment card turnover balance hit a record surplus in April, owing to the large number of foreign tourists in Iceland relative to the native population.
Continued signs of booming private consumption growth
In all, Icelanders’ card use abroad grew in April by 62% year-on-year in real terms, the strongest growth rate in the history of these statistics. This is well in line with Icelandic Tourist Board figures on Icelanders’ departures via Keflavík Airport (KEF) in April, as we have reported recently in Icelandic Market Daily. In terms of Icelanders’ overseas travel, April was the second-largest month ever, with 62,200 departures, as opposed to 67,100 when last year’s UEFA championships were underway. The Easter holidays are a factor in this, of course, as they fell in April this year but in March last year, although this is not reflected in domestic turnover, which was virtually unchanged YoY. Icelanders’ card turnover in the domestic market increased by a scant 0.2% in real terms (in terms of the CPI excluding housing), the slowest growth rate in two years. This could be due to the fact that nearly 20% of the population were travelling in April and were therefore not home giving their cards a workout. In real terms, Icelanders’ total card turnover showed solid YoY growth of 7.3% in April, albeit below the Q1 average of 10.4%.
Private consumption increasingly from abroad
The developments described above show fairly clearly that robust private consumption growth is in the offing and that a steadily increasing share of it comes from abroad. This is not only because of the surge in overseas travel by Icelanders, but also because Icelanders have greatly increased their online shopping abroad, as we have often reported in the past. In April, individuals’ card turnover abroad accounted for 17.3% of total turnover, the largest share ever recorded, as can be seen clearly in the chart below.
Tourists appear to be spending less …
Foreign payment card turnover in Iceland totalled ISK 18.2bn in April, as could be expected given that the number of guests in the country set a record for the month of April. In comparison with April 2016, tourists’ card use in Iceland was up 25% in ISK terms, well below the increase in the number of tourist arrivals (62% YoY). This trend has now continued for five months in a row. After adjusting for exchange rate movements, however, foreigners’ card turnover was up 47%, much closer to the increase in the number of tourist arrivals. This indicates that tourists pay more attention to their spending in home currency terms than in ISK terms while in Iceland, which means that they have fewer krónur to spend as the ISK appreciates against other currencies.
… but card turnover balance shows record surplus in April
Icelanders’ card turnover abroad totalled ISK 11.9bn in April, and the card turnover balance (foreigners’ card use in Iceland net of Icelanders’ use abroad) was therefore positive by more than ISK 6.4bn during the month. This is the most strongly positive card turnover balance in April since measurements began, although the YoY difference is smaller than in recent months. Nevertheless, this makes for an even more favourable services trade balance this year than in 2016.
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