Unchanged policy rate and neutral tone from the MPC

The Central Bank’s (CBI) policy rate will remain unchanged at 4.25%, according to the Monetary Policy Committee’s (MPC) new statement, published this morning. The policy rate has now been unchanged since last October. The decision was in line with our expectations and those of the market in general. All official forecasts provided for unchanged rates this time.

Today’s MPC statement was short and sweet and, for the most part, in harmony with its immediate predecessor, published in February. The February inflation measurement and Statistics Iceland’s (SI) newly published macroeconomic forecast for 2017 appears not to have changed MPC members’ view of likely near-term economic and inflation developments. Two main things have changed:

First, inflation expectations appear to have risen marginally, although is too soon to determine whether inflation expectations have become less firmly anchored to the Bank’s inflation target.

Second, the MPC statement reads as follows in one spot: “The recent decision not to terminate wage settlements reduces the short-term risk of unsustainable wage increases, but there are still underlying pressures in the labour market.” This sentence takes the place of “Furthermore, the outcome of wage settlements is still uncertain” in the last statement.

To put it as succinctly as possible, the Committee’s reduced concerns about near-term developments in the labour market are counterbalanced by a rising breakeven inflation rate in the market. The forward guidance in today’s MPC statement is neutral, as before. 

At the press conference on the interest rate decision, Governor Már Guðmundsson read an announcement about the special reserve requirement (SRR) on inflows of foreign capital into domestic fixed income investments and deposits. Under the SRR, 40% of the total investment must be held in a non-interest-bearing account with the CBI for twelve months. In the announcement, the CBI responds to recently aired criticism of the requirement. The bank does not consider it appropriate yet to make changes to the SRR but is of the view that conditions conducive to easing it will eventually develop as the interest rate differential narrows and demand pressures in the domestic economy subside. The Governor pointed out at the press conference that the CBI considered it desirable that monetary policy transmission should take place as much as possible through the interest rate channel rather than the exchange rate channel, and he noted that the SRR supported this. It could prove possible, however, to modify that SRR in the second half of this year.