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Razor-thin majority in the last policy rate decision

Two of the Central Bank (CBI) Monetary Policy Committee’s (MPC) five members were in favour of raising the policy rate more than was ultimately decided in October. It was the MPC’s most closely contested interest rate decision in nearly five years. In our opinion, the CBI’s monetary tightening phase is nowhere near its end.

Two of the MPC’s five members – Gylfi Zoëga and Gunnar Jakobsson – voted against Governor Ásgeir Jónsson’s proposal to raise the CBI’s policy rate by 0.25 percentage points, according to the newly published minutes of the bank’s October rate-setting meeting. Both wanted to raise rates by 0.50 percentage points. Gunnar is the CBI’s Deputy Governor for Financial Stability, and Gylfi is one of the MPC’s two external members.

Both of them would also have preferred to raise rates more than was done in August, but at that meeting they ultimately voted in favour of the Governor’s proposed 25-bp rate hike. Gunnar would also have preferred a larger rate hike in May. In the recent term, Gunnar and Gylfi have generally been in favour of more aggressive monetary tightening than their colleagues on the Committee have been.

This was the first time since February 2020 that the MPC’s vote has not been unanimously in favour of the Governor’s proposal, and even on that occasion, Gylfi argued against a policy rate cut. On the other hand, this is the closest policy rate vote in five years. The last time there was a 3-2 vote, in November 2016, two MPC members were in favour of a 25-bp rate cut and voted against the proposal to keep rates unchanged. The current situation shows clearly that opinion is unusually divided within the MPC at the moment.

Gylfi and Gunnar’s conviction that higher interest rates are needed has obviously grown stronger, and they are likely to continue arguing for monetary tightening at the MPC’s next rate-setting meeting in mid-November.

Unanimous commitment to a rate hike
Even though MPC members disagreed about the size of the policy rate increase, all agreed that rates should be raised, and their discussions focused on whether an increase of 25bp or 50bp was more appropriate.

The main arguments in favour of a 25-bp rate increase were as follows:

  • Continued uncertainty about the global economic outlook
  • Uncertainty about the labour market once Government support measures are unwound
  • Some of the current inflation rate can be attributed to temporary factors such as foreign supply-chain disruptions
  • There is considerable uncertainty about the interaction between rate hikes and the recent application of the macroprudential tools that are under the auspices of the Financial Stability Committee. The tools applied thus far include a reduction in maximum loan-to-value ratios, announced at mid-year, and the introduction of a 35% cap on most debt service-to-income ratios, announced at the end of September.
  • The transmission mechanism of monetary policy is probably more efficient than before, as a higher percentage of consumer mortgages are non-indexed variable-rate loans.


The main arguments in favour of a 50-bp rate increase were as follows:

  • Economic activity has rebounded strongly. On this point, MPC members cited steeply rising house prices, strong household lending growth, and a shortage of labour in certain sectors.
  • A third of firms are having difficulty filling job vacancies.
  • There is the risk of increased imported inflation in the coming term.
  • Surveys show that corporate executives widely expect price hikes, both on inputs and on their own products and services.
  • To quote the MPC minutes verbatim, it is “… important to tighten the monetary stance decisively, so as to minimise the risk that inflation [will] be even more persistent, and to respond strongly to the rise in long-term inflation expectations.”

Monetary tightening to continue in coming quarters

The MPC has raised the policy rate three times since early May 2021, to the current 1.50%. Based on the tone taken in the minutes of the October meeting and developments since then, we think the probability of another rate hike on 17 November has increased. Worth mentioning in this context is our recent inflation forecast, in which we project more persistent inflation than before. Concurrent with the November interest rate decision, the CBI will publish its last Monetary Bulletin of the year. We expect that report to sketch a picture of a more rapid economic recovery and more persistent inflation than were provided for in the bank’s August forecast. Thereafter, the outlook is for continued steady monetary tightening until inflation gives way and the real interest rate returns to something close to the pre-pandemic level.


Jón Bjarki Bentsson

Chief economist