Icelandic Financial Market Digest 16. maíPublisher: Íslandsbanki Research • Resp.Editor: Ingólfur Bender
Policy rate unchanged at 4.25%
The Central Bank’s (CBI) policy interest rate will remain unchanged for the present, as expected. Today’s interest rate decision brought with it little that was newsworthy, indicating that the views of both the CBI and the Monetary Policy Committee (MPC) are broadly unchanged. The bank expects GDP growth to average 3.0% for the remainder of the decade, and inflation to hover near the CBI target as the output gap steadily narrows.
This morning the MPC announced its decision to keep the CBI’s policy rate unchanged. The CBI’s key interest rate — the rate on seven-day term deposits — will therefore remain 4.25%, where it has been since last October. The decision was in line with market expectations. During the run-up to the decision, official forecasters were unanimous in expecting an unchanged policy rate, and the bond market’s response this morning has been muted.
The tone in the conclusion of today’s MPC statement was neutral and, in the main, similar to that in the last statement:
The outlook is for the positive output gap to narrow. Nevertheless, a tight monetary stance is still needed in order to contain rapid demand growth. The short-term risk of unsustainable wage increases has receded, but there are still underlying pressures in the labour market.
It cannot be seen from these words that the MPC anticipates changing the policy rate in either direction in the near term.
Demand pressures receding
According to the CBI’s new macroeconomic forecast, GDP growth will measure 3.3% this year, slightly below last year’s 3.6%, but in many respects the forecast is similar to the bank’s February forecast. Public investment is expected to be much stronger, and export growth weaker, than in the last forecast. As before, the bank projects rapid growth in residential investment and relatively robust growth in private consumption, although in both cases it expects the pace to slow further ahead. The CBI also projects that the current account surplus will narrow but still expects a surplus throughout the forecast horizon.
The bank’s new inflation forecast has been revised upwards, to 2.6% in 2019, as opposed to the previous 2.2%. This is mainly because it is no longer assumed that the upper value-added tax rate will be lowered at the beginning of 2019. Underlying developments in inflation are broadly unchanged from the CBI’s last forecast, however. The new forecast is similar to our own most recent forecast, predicting that inflation will remain close to the 2.5% inflation target for the rest of the decade.
Based on the CBI’s forecast, the output gap will narrow steadily over the forecast horizon. The bank estimates the 2017 output gap at about 2% in excess of potential output and projects that it will shrink to 0.3% of potential by the end of the decade.
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