We forecast a 25-point rate cut on 10 December
Another 0.25% rate cut expected on 4 February
The next rate-setting meeting after the one on 10 December is scheduled for 4 February 2015, at which time the CBI will publish its updated macroeconomic and inflation forecast. We expect the improved short-term inflation outlook to be reflected in that forecast. Inflation will be low at that time – about 1.0%, according to our forecast – and inflation expectations can be expected to have fallen still further. However, it is unlikely that private sector wage negotiations will be complete by then. We anticipate that, in view of these points, the MPC will decide to lower the policy rate by another 0.25 percentage points at its February meeting, bringing the CBI’s collateralised lending rate to 5.25%, following a three-increment reduction of 0.75 percentage points since November.
If early-2015 wage settlements are in line with the CBI’s inflation target, a further 0.25-point rate cut is possible on 18 March. Given the tenor of the discussions in the labour market, however, we consider this less likely than the alternative – i.e., that pay rises will be larger than the MPC will consider consistent with a policy rate reduction. As a result, we forecast that the policy rate will remain unchanged in March, bringing to an end the short monetary easing phase that began in November.
Monetary tightening to resume late in 2015
Inflation below CBI forecast for the short term
According to our preliminary forecast for December, inflation will average 1.2% in Q4 and 1.1% in Q1/2015. The CBI’s most recent macroeconomic and inflation forecast, published concurrent with the last policy rate decision, estimated Q4 inflation at 1.7% and Q1/2015 inflation at 2.0%. The near-term outlook is therefore much brighter than the CBI had projected, in terms of both published statistics and our own forecast. We expect this to be reflected in the bank’s new inflation forecast, which will be published concurrent with the first policy rate decision of the new year, on 4 February 2015.
In terms of annual inflation, the CBI’s real rate is now just under 4.0% and has risen by nearly 0.7 percentage points since the last policy rate decision, even in spite of the rate cut implemented then. Based on our forecasts of inflation and the policy rate, the real policy rate is expected to rise slightly over the remainder of the year, to 4.1%. It has risen steeply in the past two years, as it was negative by just over 2% by this criterion at the beginning of 2012, and the monetary stance has tightened accordingly. It may be that the real policy rate is now somewhat above equilibrium, although the assessment of the equilibrium real policy rate is always uncertain.
CBI holds the ISK steady
MPC minutes: one member voted against; another would have preferred to wait
One of the five members of the Central Bank (CBI) Monetary Policy Committee (MPC) voted against the Governor’s proposal to lower the policy rate at the MPC’s last meeting, held in advance of the 5 November policy rate decision date. Instead, this member voted to keep the policy rate unchanged. Of the four members who voted in favour of the Governor’s proposed reduction, one of them would have preferred to keep rates unchanged at this time and wait until December with a rate cut. This was revealed in the minutes from the MPC meeting.
The dissenter on the Committee said, among other things, that the interest rate decision should take account of the expectation that, further ahead, inflation would rise again because of inflationary pressures from the labour market and the diminishing slack in the economy. This member also noted that the uncertainty about the inflation outlook was somewhat concentrated on the upside.
The member who voted in favour of the rate cut but would have preferred to postpone it until December was also concerned about the unrest in the labour market. Furthermore, this member would have preferred to wait until the effects of the Government’s debt relief package on demand were known. It is now clear that shifting the debt relief measures forward in time will somewhat increase the impact on demand and inflation, which may affect the December policy rate decision.
Labour market in the cross-hairs
According to the minutes, the MPC considered the scope for pay increases in upcoming wage settlements to be limited by the slow rate of productivity growth. The Committee considered this an argument in favour of an unchanged policy rate; i.e., that it would be wise to wait until major wage settlements had been finalised, particularly in view of the time lags in monetary policy transmission.
According to figures from Statistics Iceland (SI), total hours worked were up 1.0% year-on-year in October, a statistic that the MPC considers in its interest rate decisions. Labour demand growth has lost pace in the recent term and is weak at present. For example, total hours worked rose 0.6% in Q3, as opposed to 2.7% in Q2 and 3.0% in Q1. So far this year, the pace of the labour market recovery has been somewhat below CBI forecasts.