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.”