The Board of Governors of the Central Bank of Iceland has decided to lowerthe yield in the Bank's repurchase agreements with credit institutions by 0.5percentage points, to 5.8 percent, effective at the next auction of repurchaseagreements on December 17, 2002.
The decision to lower interest rates is based on the assessment that economicdata released since the Central Bank published its latest inflation forecast inearly November 2002, has further increased the probability of inflation beingbelow target over a two year horizon. This assumes no change in monetary policyand does not take into account probable large scale foreign direct investmentprojects in the aluminium sector.
Changes in the CPI in November and December suggest that inflation in thefourth quarter will be below the Central Bank's November inflation forecast. Theinflation target was reached in November and headline inflation fell below 2% inDecember. However, in the Bank's view, headline inflation this year has notfully reflected underlying inflation. Indices of core inflation support thatview, having during the last twelve months increased slightly above the Bank'sinflation target. On the other hand, appreciation of the króna, by almost 3½%from the level assumed in the inflation forecast of the Bank that was publishedin early November, will ceteris paribus contribute to lower inflation.
The outlook for domestic demand and output growth is broadly unchanged sincethe autumn, with some slack emerging in the product and labour market next year.Economic growth in major trading partner countries, on the other hand, has beenweaker than anticipated and central bank interest rates have recently beenlowered in many of them.
It is likely that after this rate decision the bank's policy interestrate is in real terms coming close the equilibrium real rate. Consideringa forecast of a very modest slack in the economy, in the absence of large scaleinvestment projects, and taking into account that decisions on these projectsmight be made within few weeks, the timing and direction of future interest ratechanges is currently uncertain. It will as always be determined by economicdevelopments, including the decisions on the mentioned projects. Thesepotential projects will not be reflected in the interest rate level before afirm decision has been made.
The effects of the current interest rate reduction on the economy will bedetermined by its transmission to long term interest rates on the bond marketand among credit institutions, but these rates have a stronger influence onprivate consumption and investment than short term interest rates.
Further information is provided by the chairman of the Board of Governors,Mr. Birgir Ísleifur Gunnarsson, tel. 569 9600
No. 17/2002
December 12, 2002