According to the minutes, MPC members were of the opinion that there were grounds to either hold the key rate unchanged or raise it by 0.25-0.5 percentage points. The former piqued our interest, as the tone in the August interest rate decisions was unambiguously in favour of a rate hike.
The MPC’s main arguments in favour of leaving the policy rate unchanged were as follows:
- Inflation had been lower than expected in the recent term.
- The short-term inflation outlook had improved.
- Inflation expectations had fallen by some measures.
- The Bank’s real rate had therefore risen between meetings and looked set to rise further if inflation continued to fall.
- Clear signs had emerged to indicate that the Bank’s actions had begun to affect demand, as housing market activity and house price inflation had started to ease.
- Tensions in the labour market also appeared to have eased in the recent term.
- Furthermore, private consumption growth could be expected to lose pace, all else being equal, as real wages had begun to contract.
- The global economic outlook was worse than expected, particularly in view of the rising cost of living in Europe and the troubled outlook for energy supply, which could have a detrimental impact on the outlook for Iceland’s exports.
The MPC’s key arguments for a rate hike were these:
- Although inflation had fallen between meetings, it was still far above the target.
- Underlying inflation had risen.
- Long-term inflation expectations were above the target.
- The inflation outlook in trading partner countries had deteriorated, and there was the risk that second-round effects on domestic inflation would increase accordingly if firms passed higher input costs through to domestic prices.
- Annual wage inflation had been strong for some time, and in the MPC’s opinion, the labour market was still tight and domestic demand strong.
- As a result, the monetary stance was not tight enough given the business cycle position and the output gap, as the Bank’s real rate was still negative and below its equilibrium level.
- It was important to avoid easing the policy stance too soon, as this could make bringing inflation down costlier than it would be otherwise.
To refresh readers’ memory, the forward guidance from the MPC’s October decision states as follows:
The MPC will continue to ensure that the monetary stance is tight enough to bring inflation back to target within an acceptable time frame. Near-term monetary policy decisions will depend on developments in economic activity, inflation, and inflation expectations. Decisions taken at the corporate level, in the labour market, and in public sector finances will be a major determinant of developments in interest rates in the coming term.
This is a far mellower tone than the MPC has taken thus far in 2022, and it can even be said that the Committee’s forward guidance has shifted into neutral from the clear monetary tightening message earlier in the year.
Quicker on the uptake than most
The last policy rate decision of the year is scheduled for 23 November. We expect the MPC to hold the policy rate unchanged at 5.75% at that meeting, and we think it highly likely that the October rate hike represents the end of this monetary tightening phase.
The CBI’s recent responses to developments in inflation and the economic outlook have drawn considerable attention abroad. For example, the Governor was recently crowned Head of the Class by financial website Global Finance, earning a grade of A+ for the best monetary policy performance of the year, the only central banker in the world to achieve the top ranking. As is well known, many leading central banks have faced growing criticism for their tardy response to rising inflation in the recent term, and some are in the unenviable position of feeling forced to raise rates higher in response to persistent inflation at a time when the global economic outlook has soured materially.