The highlights from the MPC statement are as follows:

• Inflation now measures 5.2% and has risen once again.
• Although the January increase in the price level is due largely to changes in public levies on new motor vehicles, price hikes are still relatively widespread.
• Underlying inflationary pressures therefore continue to be persistent, even though economic activity has eased and there are clear signs that the labour market is cooling.
• According to the Central Bank’s newly published forecast, the positive output gap has closed, and the outlook is for GDP growth to be relatively weak and for inflation to taper off as the year advances.
• Despite a temporary inflation spike at the start of this year, the long-term inflation outlook is broadly unchanged.
• There is considerable uncertainty, however, as pay rises are still sizeable and inflation expectations remain above target.

The Committee’s forward guidance is virtually unchanged since November. It reads as follows:

Further decisions to lower interest rates will depend on clear evidence that inflation is falling back to the Bank’s 2½% inflation target.

As before, near-term monetary policy formulation will be determined by developments in economic activity, inflation, and inflation expectations.

For the sake of comparison, the November statement was worded as follows (boldfaced text omitted in February statement):

However, further decisions to lower interest rates will depend on clear evidence that inflation is falling back to the Bank’s 2½% inflation target.

As before, near-term monetary policy formulation will be determined by developments in economic activity, inflation, and inflation expectations.

The change in wording stems from the background to the two decisions, as the MPC lowered the policy rate in November. In essence, then, the Committee’s message is unchanged.

We actually expected the MPC to adopt a sterner tone, given that inflation has surged from 4.3% to 5.2% since the November decision. In our opinion, we think a dash of harshness would have been appropriate. In any event, it came through loud and clear at the CBI’s press conference this morning that the MPC is ready to raise rates again if inflation develops more unfavourably than is currently forecast. If inflation is above the level specified in the assumptions clause in collective bargaining agreements by late summer and contractual pay rises are revised upwards thereafter, the MPC will respond by raising interest rates, all else being equal.

New macroeconomic forecast relatively optimistic

The CBI published its new macroeconomic forecast in Monetary Bulletin today, concurrent with the interest rate decision. There the tone was fairly upbeat. The CBI projects that GDP will grow by 2% in 2026, or 0.4 percentage points more than in the November forecast. The difference between the two lies primarily in an increased capelin quota. On the other hand, the GDP growth forecast for 2027 has been revised downwards from 2.6% to 2.2%, whereas the outlook for 2028 is broadly unchanged.

The CBI’s 2026 forecast is noticeably more optimistic than our own recently published macroeconomic forecast, in which we project this year’s GDP growth at 0.6%. The tepid growth in our forecast is due to setbacks in various export sectors and the impact of those setbacks and high real interest rates on domestic demand – particularly on private sector investment. The CBI’s more favourable forecast is attributable in part to a far brighter outlook for this year’s capelin season than we had assumed. After we completed our forecast, it was reported that this year’s capelin quota will be approximately four times larger than we had assumed. Our rough estimate suggests that the quota increase will push year-2o26 GDP growth upwards by 0.3-0.4 percentage points, bringing it to around 1.0%.

The comparison between forecasts reverses in 2027 and 2028, when we project stronger GDP growth than the CBI does, as can be seen above. In the main, though, the two forecasts are quite similar: Increased GDP growth further ahead will be driven largely by stronger private consumption and robust growth in exports after this year’s headwinds.

Inflation to remain stubborn in 2026

The CBI has revised its year-2026 inflation forecast upwards. It expects inflation to measure 5% in Q1, far above the November forecast, owing mainly to a poorer initial position caused by recent price surges and end-2025 hikes in public levies. Inflation is projected to ease in coming quarters and average 4.3% in 2026 as a whole. The CBI also forecasts that inflation will fall below 3% in early 2027 and come close to the target by the middle of that year.

The CBI is also more optimistic about the long-term inflation outlook than we are. In our macroeconomic forecast, we project average 2026 inflation at 4%, but the January spike will probably push that average higher. Furthermore, we do not expect inflation to fall below 3% next year, as the CBI does. We project that, all else being equal, it will remain above target in the years ahead, averaging 3.6% in 2027 and 3.5% in 2028.

Chilly labour market

CBI officials mentioned the labour market often at this morning’s press conference, pointing out that there were unambiguous signs of cooling. The bank notes in Monetary Bulletin that, according to Gallup’s survey of businesses and households, the employment outlook has deteriorated markedly and both unemployment and the job vacancy rate have risen.

The unemployment outlook has worsened slightly, according to the CBI’s forecast. The jobless rate is projected to average 4.8% in 2026 and then ease to 4.3% in 2027. The CBI bases its forecast on the Statistics Iceland labour force survey, which fluctuates more than the Directorate of Labour’s (DoL) registered unemployment rate does. In our forecast, however, which is based on the DoL’s registered unemployment rate, we assume an average jobless rate of 4.5% this year and 3.8% next year.

Policy rate cut this spring?

Despite recent adverse developments in inflation, the poor short-term inflation outlook, and high inflation expectations by most measures, the MPC’s forward guidance gives cause to assume that additional rate cuts are more likely than rate hikes further ahead. Although we would have preferred more uncompromising forward guidance, we are convinced that the policy rate will fall again as the economy shows clearer signs of cooling and inflation tapers off.

The projections in our newly published macroeconomic forecast therefore remain unchanged after today’s policy rate decision, CBI officials’ messaging, and the discussion of the economic outlook in the new Monetary Bulletin. We expect policy rate reductions to start again in May, although there is a chance they will be delayed until Q3. Thereafter, we expect cautious rate cuts until mid-2027. If inflation does not fall more than we have forecast, and if a sizeable slack does not develop in the economy, there are constraints on how far the policy rate can fall. Given the current outlook, rate cuts will probably stop when the policy rate hits 5.5-6.0%.