Iceland to raise interest rate by half a percent

The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to raise the Bank’s interest rates by 0.5 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 5%, a statement reaching here from Iceland’s central bank said.

According to newly published national accounts, GDP growth measured 2.9% in Q1/2015. Consumption and investment grew by 6.4% and domestic demand by almost 10%. These figures, together with the strong recovery of the labour market, indicate that economic activity is growing broadly in line with the Bank’s May forecast.

Although inflation is still low, the inflation outlook has deteriorated markedly from the Bank’s last forecast, and inflation expectations have continued to rise. The outlook is for higher inflation than the Bank projected in May because wage increases recently negotiated have been significantly larger than was assumed in the May forecast.

In order to facilitate the conclusion of wage settlements, the Government has announced measures that will increase public expenditures and reduce tax revenues. This will entail an easing of the fiscal stance, other things being equal, as they have not been financed. Furthermore, the authorities have announced measures aimed to prepare for liberalisation of the capital controls. Some of these measures will generate revenues for the Treasury, and it is important that these revenues be allocated so as not to stimulate the domestic economy still further, i.e. by activating the hitherto sterile component of money holdings. The MPC will monitor developments closely and will take appropriate countervailing measures if necessary. In recent MPC statements, the Committee has repeatedly pointed out that large pay increases and strong growth in demand could undermine the recently achieved price stability and require that interest rates be raised again. The outlook for developments in wage costs, the increase in inflation expectations, and indicators of robust demand growth make it unavoidable to respond to the worsening inflation outlook now, even though inflation is still below target. Furthermore, it seems apparent that a sizeable rate increase will be necessary in August, followed by further rate hikes in the coming term, so as to ensure price stability over the medium term.

Overnight lending: 6.75%
Seven-day collateralised lending: 5.75%
Seven-day term deposits: 5.00%
Current account: 4.75%

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