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Ásgeir slashes interest rates right out of the gate

The Central Bank (CBI) Monetary Policy Committee (MPC) announced this morning the CBI’s policy rate would be lowered by 0.25 percentage points. The key rate — i.e., the rate on seven-day deposits — is now 3.50%, the lowest since the adoption of the inflation target in 2001.

With this rate cut, which is in line with analysts’ forecasts, the MPC has lowered the policy rate by a full percentage point year-to-date.

The CBI’s new governor, Ásgeir Jónsson, has therefore begun his tenure by continuing the ongoing monetary easing phase. He has signalled in interviews that there could be increased scope for further rate cuts.

The MPC statement reads as follows: “Inflation measured 3.4% in Q2 but fell to 3.1% in July. Underlying inflation has developed in a broadly similar manner. Furthermore, inflation is expected to subside faster than was forecast in May and align with the target in H1/2020. The króna has appreciated by just over 2% between meetings, and the foreign exchange market appears well balanced. Inflation expectations have fallen back to target since the MPC’s last meeting, and the monetary stance has therefore tightened slightly.”

Output forecast to contract less in 2019 than previously assumed

According to the CBI’s updated macroeconomic forecast, output will contract by 0.2% this year instead of by 0.4%, as the bank projected in May. The difference lies mainly in more resilient private consumption growth and a more favourable contribution from net trade, which partially offsets the contraction in tourism. The CBI projects that the surplus on goods and services trade will measure 3.2% this year (as opposed to 1.9% in the May forecast) and 1.6% in 2020 (up from 0.5% in the May forecast).

Tourism slump expected to persist longer than previously thought

According to the CBI’s forecast, the GDP growth outlook for 2020 has deteriorated, as the tourism industry is now expected to take longer to recover from this year’s setbacks. The bank projects year-2020 output growth at 1.9% (down from 2.4% in May) and year-2021 growth at 2.7% (up from 2.6% in May). This is in line with our macroeconomic forecast from June, as we also expect it to take longer for the economy to right itself. We project GDP growth at 1.5% in 2020 and 2.7% in 2021.

Another rate cut in the offing this year?

In view of the improving inflation outlook and the contraction that could prove more stubborn than previously thought, we forecast that the MPC will lower the policy rate by an additional 25 basis points in the near future.

The MPC statement reads as follows: “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.”

Based on our inflation forecast and the growing need for monetary easing while the economy recovers, we think it likely that the MPC will lower interest rates by another 25 bp this year or early in 2020. Thereafter, we expect rates to remain broadly steady through 2020.

Author

Bergthora Baldursdottir

Analyst

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