he CBI announced this morning that the MPC had decided to hold the policy rate unchanged. The policy interest rate (or key rate), which is the rate on seven-day term deposits, will therefore remain steady at 7.5%, where it has been since May. All MPC members voted in favour of the proposal. All published forecasts assumed an unchanged policy rate, as did most participants in last week’s Iceland Financial News survey of market participants. 

Today’s MPC statement was short and sweet. The highlights are as follows: 

• Inflation measured 4.1% in September, after rising by 0.3 percentage points from the previous month. The increase, which was anticipated, is due largely to unfavourable base effects. 
• Recent quarters have seen a clear slowing of economic activity, and demand pressures have eased in tandem with the tight monetary stance. 
• The economy remains fairly resilient, however; wage rises are sizeable, and while inflation expectations have subsided in the recent past, they are still above target. 

The Committee’s forward guidance is slightly changed from the August statement (changes in boldface): 

Many factors have moved in the right direction, but the conditions that would enable an easing of the real interest rate have not yet emerged. Further interest rate cuts will depend on whether inflation moves closer to the Bank’s 2½% 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 forward guidance from August is as follows: 

Although inflation has eased and inflation expectations have fallen in the recent term, inflationary pressures remain. The conditions that would enable an easing of the real interest rate have therefore not emerged. 
(Note: The comparison here pertains to the original text in Icelandic where the word "enn" which translates to "yet" was first added in October. In the English translation of the August MPC statement, the word "yet" was already present.)

In other words, the MPC is continuing to make its next policy decisions contingent upon a decline in twelve-month inflation, as it has done since May. We were actually sorry not to see a reminder that interest rates may need to rise again if inflation develops unfavourably, but any doubts on that score were put to rest at the press conference following the announcement. 

Cooling economy complicated by persistent inflation 

The word “yet” in today’s statement drew considerable attention, and at the press conference Governor Ásgeir Jónsson and Deputy Governor Þórarinn G. Pétursson were asked why it had been added to the Committee’s forward guidance this time. In response, they said the resumption of rate cuts was probably closer at hand now than it had been in August, both because time had passed since then and because the economy was apparently cooling faster than previously expected.  

The MPC statement made no mention of the collapse of airline Play, indicating that the Committee’s decision had not been strongly affected by it. Nevertheless, Ásgeir and Þórarinn mentioned at the press conference that Play’s failure, together with other negative news such as the worsening outlook for pelagic fish catches in 2026 and headwinds in the energy-intensive sector, could chill the labour market and the economy as a whole more rapidly than previously anticipated. On the other hand, they appended a big question mark to Statistics Iceland’s (SI) newly published national accounts, which showed a 1.9% contraction in GDP in Q2/2025, positing that revised figures would probably indicate greater resilience in H1. We share that opinion, as we explained recently in our discussion of the national accounts figures.  

When asked about the recent intransigence of inflation expectations and what it meant, Ásgeir and Þórarinn agreed that high inflation expectations were a significant cause for concern but that once inflation itself started to ease, expectations could be expected to follow suit, as is often the case when expectations become unmoored from target. 

When will interest rates start falling? 

Because neither we nor the CBI forecast a noticeable decline in inflation before spring 2026, any policy rate cut before then depends on one of two scenarios: 

• Inflation develops more favourably than projected and inflation expectations do likewise; 
• The economic outlook deteriorates so much that it affects the inflation outlook and inflation expectations over the medium term. 

It is worth remembering here that economic developments ultimately affect monetary policy only to the degree that they change the medium-term inflation outlook and inflation expectations. Unlike the US Federal Reserve, for instance, the Central Bank of Iceland does not have a dual mandate of pursuing full employment as well as price stability. Although CBI officials believe it will be possible to bring inflation back to target without a hard landing of the economy, they stressed at this morning’s press conference that this was not a given. 

If matters develop as expected and neither of the two above-described scenarios materialises, we continue to assume that the policy rate will be held unchanged through this year and then start to fall sometime next spring. 

Responses in the bond market suggest that the interest rate decision and the tenor of today’s press conference came as no surprise. As of this writing (11:30 hrs), market yields have hardly budged and turnover has been limited.