We project that the Central Bank of Iceland (CBI) Monetary Policy Committee (MPC) will decide to hold the bank’s policy interest rate unchanged at 9.25% on 22 November, its next decision date. Developments in the seismic activity on the Reykjanes peninsula could overshadow the conventional status check on the domestic economy, inflation movements, and the inflation outlook. If it comes clear before the interest rate decision that a potential volcanic eruption is unlikely to cause substantial damage to the economy in the near future, an increase of 0.25 percentage points is not out of the question, but as is stated above, we think an unchanged policy rate is the likeliest outcome.
Reykjanes in the crosshairs
As of this writing, there is still considerable uncertainty about how the geological situation in the Reykjanes area will play out. Developments from now until the decision date will presumably be a major factor in the decision itself. Notably, the MPC has said not a word, to our knowledge, about previous eruptions during the current spate of seismic activity. But that could change now, unless the outlook shifts radically in the next few days.
Naturally, we are not geologists, and as a result, we rely on scenarios that experts in the field have provided to the media and outlined in recent press conferences. Briefly, we envision three possible scenarios for the MPC’s decision, based on how matters develop on Reykjanes from now until the decision date:
- Continued uncertainty about developments on the Reykjanes peninsula: There are strong grounds for taking a wait-and-see approach, leaving the policy rate unchanged and awaiting further developments between this month and the next decision date, in early February 2024.
- The probability of an eruption has diminished significantly, or an eruption has begun but is expected to have limited impact on transportation, infrastructure, and the economy: The policy rate decision would depend on other factors, and the assessment would be similar to that before the earthquakes began, which is discussed more fully below.
- A volcanic eruption has begun, with major impact on transportation, infrastructure, and/or the economy (at least two of these): The policy rate would be kept unchanged and the possibility introduced of a rate cut in the near future if the economic setback is likely to be significant.