The Board of Governors of the Central Bank of Icelandhas decided to lower the yield in the Bank's repurchase transactions with creditinstitutions by 0.5 percentage points effective at the next auction ofrepurchase contracts on April 2, 2002. The interest rate on the current accountsof credit institutions in the Central Bank will be lowered by 0.5 percentagepoints on April 1, 2002, but the rate on overnight advances will beunchanged.
As reported in the February issue of the Monetary Bulletin of the CentralBank, the Bank felt at that time that there were no grounds for a decrease ininterest rates for the time being. Nevertheless, the underlying assumptionscould change fairly quickly. Exchange rate and price developments in the weeksand months to come would be an important factor in that respect. The exchangerate of the króna has now appreciated by 2.3 percent since January 21 when theassumptions underlying the latest inflation forecast of the Bank were fixed.Furthermore, the two most recent measures of the CPI indicate a low underlyingrate of inflation so far this year. That development is partly explained by thespecial effort undertaken to contain price increases. Its long-term impact oninflation is uncertain. In addition, it is possible that the impact of theexchange rate depreciation in 2000 and 2001 may still be felt in the periodahead if the exchange rate of the króna does not appreciate further. However,developments over the last few weeks have overall increased the likelihood thatinflation this year will be in line with the inflation forecast of February.
The Economic Indicators of the Central Bank published last week confirm thatthe labour market is slackening. There are also indications that the creditexpansion of deposit banks continues to slow down. In addition, according to thelatest information from the National Economic Institute, the positive output gapis likely to disappear this year. These developments were by and large foreseenwhen the Bank published its most recent inflation forecast according to whichthe inflation target was not going to be reached in the course of 2003. Theappreciation of the króna in recent weeks and the relatively favourabledevelopment of prices in the last two months increase the likelihood ceterisparibus that the inflation target will be reached in 2003. The Central Bank willpublish a new inflation forecast at the beginning of May.
Despite the 0.5 percentage point reduction in interest rates now, realCentral Bank interest rates remain high, particularly in light of the forecastrate of inflation. Thus, considerable monetary restraint continues to beapplied. The Bank deems that to be unavoidable for still some time in order toensure the attainment of the inflation target. As inflation has beenconsiderably above an acceptable level in the recent past, monetary policy mustfirst and foremost aim at reducing it.
In his address to the Annual Meeting of the Central Bank on March 26, 2002,the Chairman of the Board of Governors presented the analysis of the Bank ofmonetary and economic developments, current conditions and prospects that interalia formed the background to the interest rate decision of the Board ofGovernors.
Nr. 3/2002
March 27, 2002