The highlights from the MPC statement are as follows:

• Inflation measured 4.2% in February, its lowest in four years.
• The decline in inflation has been broad-based, and underlying inflation has therefore fallen as well.
• The outlook is for continued disinflation in coming months.
• Demand growth has subsided in line with a tight monetary stance, and capacity pressures have eased.
• By the same token, housing market activity has slowed.
• Nevertheless, high-frequency indicators could suggest that households have stepped up their consumption spending.
• In addition, wage costs have continued to rise steeply, and inflation expectations remain above target.

Economy shows signs of resilience despite high interest rates

At this morning’s press conference in which CBI officials explained the interest rate decision, it was emphasised how positive it has been to see that inflation excluding housing has been within striking distance of the inflation target in the recent term. On the other hand, it would be preferable to see more unambiguous signs of a cooling housing market in the months ahead. Persistently high inflation expectations were certainly cause for concern, but it was hoped that continued disinflation in coming months would cause expectations to fall as well.

Furthermore, CBI officials noted that the economy was resilient in spite of the tight monetary stance. In the main, the economic outlook had not changed significantly relative to the CBI’s most recent forecast, published in the February 2025 Monetary Bulletin. Real interest rates were still being intermediated through the economy and were clearly affecting economic activity. Even so, there were no signs of a material increase in financial distress or insolvency, and all else being equal, a hard landing in the economy was not expected. This was positive in and of itself, but it limited the scope for monetary easing in the near future.

Recently published consumption-related indicators could suggest that households’ consumption spending has picked up again. One such indicator was the steady growth in payment card turnover, but the link between it and private consumption was hardly clear-cut, mainly because of the steep drop in motor vehicle purchases, as we have discussed recently. Car purchases were rebounding, however, at a time when surveys indicated growing consumer optimism about the economic and labour market outlook. Private consumption was expected to strengthen in the near term, but it was uncertain how much.

In response to questions, Governor Ásgeir Jónsson and Deputy Governor for Monetary Policy Thórarinn G. Pétursson said that although a potential trade war would have a dampening impact on GDP growth, its impact on inflation was more uncertain, owing to the possibility of sluggish exports and weaker demand growth, on the one hand, and cost increases from abroad and a weaker ISK, on the other.

Gradual monetary easing ahead

The forward guidance in today’s MPC statement is virtually identical to that in February. It reads as follows:

Although inflation has eased and inflation expectations have fallen in the recent term, inflation pressures remain, which calls for a continued tight monetary stance and caution regarding decisions going forward. This is compounded by significant global economic uncertainty.

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 February statement read as follows:

Although inflation has eased and inflation expectations have fallen, inflation pressures remain, which calls for a continued tight monetary stance and caution regarding decisions going forward. This is compounded by elevated global economic uncertainty.

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

We interpret the forward guidance and the tone struck at today’s press conference as an indication that the MPC wants to remain cautious as long as signs of a slack in the economy are no clearer than they currently are and inflation expectations are as high as they have proven to be. A “tight monetary stance” probably means a real policy rate of around 4% in the near term.

Our preliminary forecast is for a 0.25 percentage point policy rate cut in May, following by a combined reduction of another 1 percentage point in H2/2025 as a whole. If inflation turns out more persistent than we expect and inflation expectations do not fall do any significant degree, rate cuts could come more gradually, but on the other hand, stronger signs of a cooling economy and favourable developments in inflation and inflation expectations could expedite the process.