Policy announcement by the Board of Governors of the Central Bank of Iceland:
The Board of Governors of the Central Bank of Iceland has decided to leave the Bank’s policy interest rate unchanged at 14.25%. Inflation has fallen, but more slowly than was expected in the Central Bank’s forecast in March 2007. Underlying inflation is still far above the inflation target. The medium-term inflation outlook is considered broadly unchanged since March.
The policy rate is high in real terms and is reflected in yields on both nominal and indexed bonds. Contributing factors have been the monetary policy statement and policy rate forecast published in Monetary Bulletin in March 2007. The full impact of higher bond yields may still not have been transmitted to credit institutions’ lending rates.
Economic developments so far in 2007 appear to have unfolded broadly in line with the Central Bank’s macroeconomic forecast published at the end of March. However, merchandise exports are probably greater than forecast then. Rapid employment growth indicates that economic activity over the coming months will be at least as high as forecast.
Favourable conditions in global financial markets, high domestic interest rates and upbeat sentiment in the economy have contributed to strengthening the króna. The wide current account deficit and relatively high real exchange rate continue to pose a risk of a depreciation, for example if global financial conditions deteriorate. Such a development could cause inflation prospects to worsen, especially if the depreciation precedes an easing of conditions in the labour market, which shows no sign of occurring yet. The impact of wage rises far in excess of productivity growth over the past year may still not have been transmitted to prices in full.
According to the Central Bank’s forecast in March, the inflation target will be attained in Q3 this year, or next year if the effect of the cut in consumption taxes in March is excluded. Although the current outlook is broadly unchanged, the Central Bank underlines again the upside risk to the inflation profile. Recent price developments, ongoing labour market pressures, a wide current account deficit and robust demand underline this risk. If the inflation outlook deteriorates from the March forecast, the Central Bank will need to respond.
The next interest rate decision by the Board of Governors of the Central Bank of Iceland will be announced on July 5, 2007, coinciding with the publication of a new macroeconomic and inflation forecast in Monetary Bulletin.
No. 8/2007
May 16, 2007