Our forecast: unchanged policy rate on 1 October
We expect the Central Bank (CBI) Monetary Policy Committee (MPC) to decide to hold the policy rate unchanged on 1 October, the next announcement date. We expect the bank to base its decision on several arguments: inflation is at target, the ISK is stable, and the inflation outlook is good. Indeed, according to its most recent inflation forecast, the CBI expects inflation to remain at target throughout the forecast horizon, which extends into 2017.
We forecast that the MPC will keep the policy rate unchanged until the latter half of next year. This is a change from our last forecast, as we previously projected that the MPC would begin a nominal monetary tightening phase early in the year. This change in our forecast is underpinned by two factors: the improved inflation outlook and the milder tone in the statement accompanying the MPC’s last decision. According to the statement, the CBI’s current baseline forecast indicates that the current interest rate will suffice to keep inflation at target. In that statement, the MPC makes reference to the aforementioned inflation forecast and its major determinants.
Inflation below target
Inflation measured 2.2% in August. It has been below the CBI’s inflation target for seven consecutive months and looks set to hover at this level throughout the year. We forecast it to measure 1.9% at the year-end. This lack of short-term inflationary pressures is due to a number of factors, including extremely low imported inflation, as the ISK is stable and foreign prices of various goods – food and petrol among them – have fallen rather than rising in the recent term. Furthermore, wage pressures remain relatively modest, probably because the moderate nominal pay increases negotiated in the early 2014 wage settlements are generating reduced inflationary pressure.
For next year, we project somewhat higher inflation than in 2014. Presumably, increased economic activity will be reflected in swifter pay rises and continued increases in real house prices. We project inflation to average 2.7% in 2015 and 3.0% in 2016. Our long-term forecast is based on several assumptions: that house prices will rise by 5-7% per year throughout the forecast horizon, that wage hikes will gain pace in the near future as tension grows in the labour market, and that the ISK exchange rate will remain broadly unchanged. Our forecast is well in line with the CBI’s most recent forecast, published concurrent with the 20 August policy rate decision.
ISK exchange rate stable
The exchange rate of the króna has been very stable since May, after having risen last winter and this spring. Exchange rate volatility subsided noticeably after the Central Bank’s (CBI) Monetary Policy Committee (MPC) decided to step up the bank’s intervention in the foreign exchange market in May 2013, previous MPC statements emphasising the importance of using the CBI’s monetary policy instruments to promote price stability. The scheme worked quite well, it must be said, as inflation has hovered around the inflation target since February 2014, making this the longest period of target-level inflation since 2003. for the express purpose of smoothing out swings in the ISK exchange rate. The changes were in line with
According to the minutes from the MPC’s last meeting, MPC members agreed that the CBI’s FX market activity in the past year had contributed to greater exchange rate stability. That being the case, the Committee considered it appropriate that the bank continue regular foreign currency purchases in the current amount as long as conditions remain relatively unchanged, and that it continue intervening in the market as needed to mitigate exchange rate volatility.
MPC unanimous at last rate-setting meeting
According to the minutes of the Central Bank (CBI) Monetary Policy Committee’s (MPC) last meeting, all members voted in favour of the Governor’s proposal to keep the CBI’s policy rate unchanged on 20 August. This was as expected, as well as being in line with the recent tide of support for an unchanged policy rate, with the MPC voting unanimously to keep rates unchanged since February of this year. There was little or no uncertainty about this decision, and all official forecasts projected it accurately, ours included.
The big news in the MPC’s statement of 20 August was the marked softening in the tone taken by the Committee as regards upcoming monetary policy decisions. According to the statement, the CBI’s baseline forecast indicated that the current interest rate would suffice to keep inflation at target. This weakens expectations of a rate hike in the near future and had a strong effect on the bond market.