MPC unanimous

According to the minutes of the last meeting of the Central Bank’s (CBI) Monetary Policy Committee (MPC), members voted unanimously to keep the policy rate unchanged on the CBI’s last interest rate decision date, 4 February. This is the first time since last October that the Committee has been in full agreement. 

Wage settlements a major determinant of near-term monetary policy

The minutes of the meeting indicate that MPC members’ concerns about upcoming wage agreements have escalated since the December meeting. Members were of the opinion that the contracts negotiated since the December meeting and indications that recent agreements would affect wage demands in the near future had reduced the likelihood that relatively moderate three-year agreements would be landed. 

According to the minutes, Committee members were of the opinion that, if inflation remains below target and pay increases in upcoming wage settlements are consistent with the inflation target, conditions for further reductions in nominal interest rates could develop, other things being equal. On the other hand, they were of the opinion that large pay increases and strong growth in demand could undermine the recently achieved price stability and require that interest rates be raised again. These statements make it clear that the outcome of the wage negotiations will be a major factor in subsequent monetary policy decisions. Until then, however, it appears that the MPC will keep rates unchanged. 

Inflation forecast too low?

The minutes state that although the inflation outlook improved markedly between interest rate decisions and the CBI’s real rate had risen, the MPC had already factored these developments into the decision taken at its December meeting. In addition, the Committee considered it likelier that the bank’s most recent inflation forecast was too low rather than too high. 

As is explained in the MPC statement of 4 February, the Committee does not take full account of the disinflation stemming from the decline in fuel prices in H2/2014 and resulting rise in the real rate. The Committee considered it unlikely that the drop in fuel prices would affect long-term inflation expectations and wage formation but would respond if such an effect should surface. 

Policy rate likely unchanged in March 

In our opinion, the forward guidance implied in the MPC’s statement and minutes is a clear indication that the policy rate will remain unchanged in the near term. The following observations from the minutes are worth noting in this context: “The spare capacity in the economy had more or less disappeared, and strong GDP growth was expected in the near future. Wage growth had been strong in Iceland, unlike in most trading partner countries, and mounting unrest in the domestic labour market could jeopardise the stability that had been achieved. For this reason, the Committee agreed that it was appropriate to wait until the economic situation became clearer, particularly as regards wage developments.” Because a majority of the wage agreements under consideration will probably still be pending on 18 March, the next rate-setting date, we think it highly likely that the MPC will decide to keep rates unchanged at that time. We consider the chance of a rate cut in coming quarters to have diminished as well.