The Board of Governors of the Central Bank of Iceland has decided to
raise the policy interest rate in the Bank's repurchase transactions by 0.2
percentage points to 5.5%, effective at the next auction of repurchase contracts
on May 11, 2004.
This decision is based on the Bank's most recent
macroeconomic and inflation forecasts, which were published in Monetary Bulletin
on March 17 this year, and subsequent economic developments. All things being
equal, inflation was forecast to exceed the Bank's target in the third quarter
of 2005, with the output gap turning from negative to positive in the near
future. Against this background, the Bank declared that, all things being equal,
the inflation forecast called for a rise in the policy interest rate in the next
few months.
Unfolding developments in recent weeks have confirmed
important assumptions underlying the forecast. Agreements have been signed on an
expansion to the Norðurál aluminium smelter and the latest indicators show
ongoing growth in domestic demand as well as a tightening in the labour market.
It is likely that inflation will exceed the Bank's target sooner than was
assumed in the March forecast, given that long-term interest rates have been
falling and that the Consumer Price Index has risen by more than market
expectations in the past two months and the króna is currently 3.7% weaker than
assumed then. Higher oil prices could drive the CPI above the inflation target
in the next few months, although such factors are normally ignored in monetary
policy implementation.
In light of the above, the Central Bank now
considers there are grounds for launching the process of tightening the monetary
policy stance that it has been signalling in recent months. As always, the
timing and scope of the next steps will depend on unfolding developments. The
Central Bank of Iceland will release new macroeconomic and inflation forecasts,
together with an assessment of economic and monetary developments and prospects,
in the next issue of Monetary Bulletin, which will be published on June 1.
For further information, contact Birgir Ísleifur Gunnarsson, Chairman of
the Board of Governors of the Central Bank of Iceland, tel. (+354) 569 9600.
No. 9/2004
May 6, 2004