This news is more than six months old

Central Bank raises interest rates by 0.5 percentage points

The Central Bank (CBI) announced its fourteenth consecutive policy rate hike this morning. The statement issued by the bank’s Monetary Policy Committee (MPC) is quite different from its predecessor, and relatively neutral. Presumably, the CBI is approaching the finish line with this monetary tightening episode, and today’s rate hike may well be the last for the time being.

The CBI announced this morning that the MPC had decided to raise the CBI’s policy rate by 0.50 percentage points. The CBI’s key interest rate – the rate on seven-day term deposits – will therefore be 9.25% and will have risen by 8.5 percentage points in the past two years or so. The policy rate is now at its highest since year-end 2009. Forecasters projected that rates would be raised by 0.25-0.50 percentage points, including our own forecast of a 0.25-point rate hike.

The MPC mentions in this morning’s statement that the contribution of the housing component to inflation has diminished, global price hikes have subsided, and the króna has appreciated, yet domestic price increases have proven persistent and remain widespread. The labour market is still very tight and strong demand pressures remain in the overall economy, although there are signs that economic activity has begun to slow down. The short-term inflation outlook has improved, but long-term inflation expectations are well above target, and the risk remains that inflation will become entrenched.

GDP growth projected to ease in the coming term

The CBI has issued an updated macroeconomic forecast in Monetary Bulletin, published alongside today’s interest rate decision. The bank anticipates that GDP growth will be weaker in 2023 as a whole, or 3.5% instead of the 4.8% it forecast in May. The main reason for the revision is a faster-than-expected reversal of domestic demand. GDP growth prospects for 2024 and 2025 are unchanged from the CBI’s May forecast, however.

As the chart above indicates, the CBI’s May forecast for 2023 was considerably more optimistic than those from other forecasters. Today’s update is better aligned with other analysts’ projections. We project this year’s output growth at 3.1%, although that forecast dates from May.

The CBI has revised its year-2023 unemployment forecast downwards. There are still clear signs of considerable tension in the labour market. The CBI forecasts 2023 unemployment at 3.3%, down from the 3.7% in its May forecast, and next year it expects the jobless rate to inch upwards as demand pressures in the labour market ease.

The short-term inflation outlook has improved, but the long-term outlook is broadly unchanged since May. The CBI has revised its year-2023 inflation forecast downwards from 8.8% to 8.6%, citing a stronger ISK and weaker economic activity as the chief reasons for the change. The bank predicts that inflation will decline slowly and will not fall below 4% until the end of 2024. The CBI’s updated inflation forecast is in line with our own August forecast, although we are somewhat more upbeat about the 2023 inflation outlook.

Significant change in forward guidance – will this be the last rate hike for the time being?

The MPC’s forward guidance is quite different from that accompanying the last interest rate decision. This time it is relatively middle-of-the-road, reading as follows: “ … Indicators imply that the effects of recent interest rate hikes are coming more clearly to the fore, and near-term monetary policy will be determined by developments in economic activity, inflation, and inflation expectations.”

For the sake of comparison, the May statement read as follows: “ … Therefore, the outlook is for further rate hikes in order to ensure a better balanced economy and bring inflation back to target.”

As these two sentences show, the MPC is far more neutral now than it was in May. As regards the situation further ahead, Governor Ásgeir Jónsson said at this morning’s press conference that the MPC would have to wait and see what the next few months bring. It is therefore conceivable that the current monetary tightening episode is at an end, but a 25-bp rate hike in October or November cannot be ruled out, either.

The next interest rate decision is set for 4 October, by which time economic developments will have grown a bit clearer. The Q2 national accounts will be published at the end of this month, and inflation figures for August and September will be available by the time of the October meeting.


Bergthora Baldursdottir