07 September 2007

English summary from the Board of Governors' press conference on September 6.

The following is an English summary of the main questions and answers after the formal introduction by the Chairman of the Board of Governors at the Press Conference on September 6, 2007.

Question: What is your reaction to the decision by Straumur-Burðarás Bank to switch its capital into euros? Do you have an opinion on the matter?

Davíd Oddsson, Chairman of the Board of Governors: I might have an opinion but the Board of Governors has not adopted a standpoint. I see no need to do so. It’s not a major issue. That’s all there is to say about the matter.

Question: What about the Minister of Commerce’s claims about substantial pressure from the business community to adopt the euro.

Chairman of the Board of Governors: He may feel some pressure, but we don’t here.

Question: Calls have been made from various quarters on the need for the Central Bank to change the policy rate. How do you intend to respond? Do you take these comments into account?

Chairman of the Board of Governors: Of course we listen to such comments. The IMF argued that even under current conditions there could be grounds for raising the policy rate. That is a valid argument but we underline that there are counterarguments and on balance the Board of Governors decided it was prudent to leave the rate unchanged. The policy rate is high in real terms and the monetary stance is tight – we hope it is adequate, but also say that if the current outlook worsens, a response will be forthcoming. A policy rate hike cannot be ruled out, just as if conditions change in the other direction, we do not rule out lowering it earlier than previously expected. The July forecasts do not imply that the policy rate will come down sooner, but it is our duty to take account of medium-range developments when we make our next decisions.

Question: What will be the impact of fishing quota cuts and the government’s measures to mitigate their effect?

Chairman of the Board of Governors: When the July forecast was prepared we used a specific assumption for the cutback in the cod quota. This was not because the Bank considered this to be the correct level for the cutback, but because we needed an assumption for our calculations. The cutback that was eventually decided was rather more than we had assumed, but the economic impact is highly uncertain and will not be clear until well into the next year, so it could not be included in the Board of Governors’ current policy rate decision. The mitigating measures are also uncertain although some have been announced. However, in the present climate we point out the need to design such measures or any others carefully when the fiscal budget is drawn up.

Question: Do you fear that such measures could increase pressures in the economy?

Chairman of the Board of Governors: We don’t take that for granted, but given the tight labour market and strong pressures in much of the economy, we advise the government to proceed cautiously in its fiscal budget and expenditure plans. We also realise that the cod quota cutback will have a sizeable localised impact, plus a psychological effect in certain areas and sectors. We do not play that down.

Question: Given the tight labour market, is it realistic to cut the policy interest rate in March, as you expected previously?

Chairman of the Board of Governors: Actually we present the question in different terms and say it is unrealistic to expect the policy rate to be cut until the first half of next year. We said that in July and still do. We also reiterate our qualification that a deterioration in the outlook could lead to a policy rate hike or the reduction would begin later, but a different development could lead to a different conclusion.

Question: Have US sub-prime market developments affected your decisions?

Chairman of the Board of Governors: To some extent. They have an impact here and on the global economic climate and credit terms, and on financial institutions worldwide and in Iceland too. A downturn in market conditions would tend to ease pressures in Iceland and therefore reinforce the Central Bank’s stance. Such events affect Iceland and we have to take them into account like everything else. We do not have information about Icelandic banks being in the same position as other institutions vis-à-vis this particular risk. Nonetheless, shifts in global markets have an impact on their performance and finances.

Question: An American economist and opponent of small currencies visited Iceland recently. Do you think the time has come to launch a serious debate to examine the euro as a currency for Iceland?

Chairman of the Board of Governors: Many in-depth reports have already been made. The Central Bank produced such a report in 1997 which still seems to be perfectly valid. Other reports were made in 1998, so the debate has been addressed in full seriousness. But my personal view is that calling in experts who quote countries that have messed up their finances and then latch themselves on to, say, the dollar, then sitting starry-eyed to hear them claim this is some kind of solution for Iceland – to tell the truth it makes me laugh. This isn’t a conclusion reached by the Board of Governors. I’m just saying what I think. I find it hilarious.

Question: So you don’t think this is the right time to resume this debate and examine it afresh?

Chairman of the Board of Governors: An on-going, normal dialogue is natural. But the idea of adopting another currency without participating in full in the union behind it is ridiculous. Anyone with any sense knows that. Importing people to talk nonsense on the subject and staring starry-eyed at them while they do, that’s hilarious.

Question: There have been reports in recent weeks of other central banks lending to banks. Has the Central Bank of Iceland examined whether to take measures in connection with the current market turbulence?

Chairman of the Board of Governors: This has happened abroad because liquidity has temporarily dried up in financial markets. Not necessarily because assets are lost, but because of unease and lack of confidence. Banks are not lending to each other because they are not sure of prompt repayments by borrowers, and so forth. Under such conditions, central banks in Europe and the US have eased their rules and pumped liquidity into the system. They have been moving closer towards our arrangements, i.e. we impose no ceiling on facilities but banks can borrow as they require from the Central Bank if they have adequate collateral. Elsewhere, there are quantitative ceilings on credit facilities. These problems have not arisen in Iceland. Earlier this year the Central Bank extended its definition of eligible collateral for its facilities. This was not a response to the problems that have now emerged abroad, but solely to keep the financial markets and payment system smoothly oiled. This is a function of central banks. You could say the central banks should oil the engine, not fill the tank. In 1929 the central banks did the opposite and magnified the depression. Demands for intervention have not arisen in Iceland, they have been unnecessary because the money market and payment systems seem to be functioning well and fulfilling their purpose. But we do monitor developments very carefully in close contact with the banks, and consider that the situation is in order.

Governor Eiríkur Gudnason: As Governor Oddsson says, we keep a close watch on shortcomings and whether we need to respond. We see no reason to change anything now.

Chairman of the Board of Governors: As you know we provide very large facilities every week. The amount of collateral loans can reach 200 b.kr. This arrangement works very well in our market, so the króna market is functioning properly.

Question: The IMF recently said that the Icelandic króna was overvalued by 15-20%. Does the Central Bank share that opinion and what exchange rate scenario does it foresee?

Chairman of the Board of Governors: We have not heard an exact figure of this kind. However, it has repeatedly been stated in Monetary Bulletin and Central Bank material that the króna probably is and has been rather strong. So it is likely to weaken in the long run.

Governor Ingimundur Fridriksson: The Fund’s calculations were made in the spring when the króna was stronger than at present. That should be borne in mind when looking at the calculated relative overvaluation. The IMF report also emphasised as I recall the great uncertainty surrounding these calculations. It is difficult to state a specific figure for a correct exchange rate.