27 January 2010

Statement of the Central Bank of Iceland Monetary Policy Committee: Central Bank rates lowered

The Monetary Policy Committee (MPC) has voted to lower Central Bank interest rates by 0.5 percentage points. The deposit rate (current account rate) will be lowered to 8%. The maximum bid rate for 28-day certificates of deposit (CDs) will be 9.25%. The seven-day collateral lending rate will be 9.5% and the overnight lending rate 11%.

The króna has been broadly stable since the last MPC meeting, and indeed since last summer, without any Central Bank intervention since early November. This stability has continued despite internal and external developments that could have been expected to affect the króna negatively, in particular the recent turmoil caused by the president’s decision not to sign the Icesave legislation. This reflects the effectiveness of the capital controls, as well as a gradual improvement in the underlying current account balance.

The failure to resolve the dispute over compensation of depositors in foreign branches of Landsbanki has already triggered a sovereign credit rating downgrade to non-investment grade by one of the rating agencies and could delay the second review of the IMF programme.

Consequently, access to bilateral and multilateral financing, a prerequisite for successful access to international capital markets, might also be delayed. Given the effectiveness of the capital controls, the short-run effect on the króna should be modest; however, further steps towards removing the capital controls would be risky given the above uncertainties.

Inflation continued to decline in December and January, slightly more than in the November forecast, measuring 6.6% year-on-year in January, or 5.2% excluding the impact of higher consumption taxes. The 0.3% drop in the CPI in January was unexpected; however, underlying inflation is forecast to subside more slowly than in the November forecast throughout 2010, although it is still expected to reach the inflation target late this year.

If the króna remains stable or appreciates, and if inflation continues to fall as forecast, there should be scope for continued gradual monetary easing. However, as long as there is significant uncertainty about Iceland’s future access to foreign capital markets, the MPC will have limited room for manoeuvre. As always, the MPC stands ready to adjust the monetary stance as required to achieve its interim objective of exchange rate stability and ensure that inflation is close to target over the medium term.

No. 2/2010
27 January 2010