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Iceland raises rate to rein in accelerating inflation

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     Iceland’s central bank raised its key interest rate for the first time 2-1/2 years, saying a tightening of its monetary policy stance was necessary to ensure inflation expectations remain anchored to its target at a time of stronger-than-expected economic growth and accelerating inflation.
     The Central Bank of Iceland (CBI) raised its rate on 7-day deposits by 25 basis points to 1.0 percent, its first rate hike since November 2018 when it tightened policy for a brief six months before changing course in May 2019 due to a sharp deterioration in the country’s economic outlook.
     The economy of the North Atlantic island, which had recovered after the Global Financial Crises dealt it a devastating blow, was first hit by a plunge in tourism, then a collapse in the export of capelin due to rising ocean temperatures and finally the COVID-19 pandemic.
     Between May 2019 and November 2020 CBI cut its key rate 10 times and by a total of 3.75 percentage points, including five times last year.
     But since May 2020 inflation has been above the central bank’s target and since the start of this year it has been over 4.0 percent. In April it rose to a higher-than-expected 4.6 percent.
    “Inflationary pressures appear to be widespread, as underlying inflation is broadly similar to headline inflation,” CBI said, pointing to a depreciation of its krona and steep rises in wages and home prices.
    “As a result, it is necessary to raise the Bank’s interest rates in order to ensure that inflation expectations are anchored to the target,” it added.
    The recovery of Iceland’s economy has also been stronger than the central bank had assumed and it forecast growth this year of just over 3.0 percent and more than 5.0 percent in 2022.
     The Central Bank of Iceland issued the following statement:

“The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to raise the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 1%. 

The economic recovery in H2/2020 was stronger than previously assumed. According to the Central Bank’s new macroeconomic forecast, published in the May issue of Monetary Bulletin, the outlook is for just over 3% GDP growth this year and more than 5% growth in 2022. The outlook has improved since the Bank’s last forecast, owing largely to signs of a stronger recovery of domestic demand. Unemployment has eased, although it remains high. The slack in the economy therefore appears to be smaller and looks set to close sooner than previously estimated.

Supply-side disruptions due to the COVID-19 pandemic have pushed production and distribution costs upwards worldwide, and global oil and commodity prices have risen steeply in the recent term, although these increases may prove to be temporary.

Inflation has therefore been higher and more persistent than previously forecast, measuring 4.6% in April. Inflationary pressures appear to be widespread, as underlying inflation is broadly similar to headline inflation. This is due to a number of factors, including the depreciation of the króna in 2020 and steep rises in wages and house prices. As a result, it is necessary to raise the Bank’s interest rates in order to ensure that inflation expectations are anchored to the target.

The MPC will apply the tools at its disposal to ensure that inflation eases back to the target within an acceptable time frame.”


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