Our forecast: unchanged policy rate on 18 March
We expect the Central Bank (CBI) Monetary Policy Committee (MPC) to decide to hold the policy rate unchanged on 18 March, the next announcement date. We think it likely that the Committee consider it appropriate to wait until the lines are drawn more clearly as regards wages – in particular, to wait until the current private sector wage negotiations have been concluded. It is all but impossible that the contracting parties will have landed an agreement in advance of the upcoming policy rate date. We expect the MPC to take account of the risk that labour market unrest could derail the recently achieved price stability.
Our forecast is in accordance with the forward guidance found in the MPC’s last statement and the minutes from its last meeting, which suggests strongly that the Committee is likely to keep rates unchanged for the present. A noteworthy statement in the minutes is this one:
“The spare capacity in the economy had more or less disappeared, and robust 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.”
Inflation to gather pace as the year progresses
Inflation now measures 0.8% and is unchanged since the February interest rate decision. Low global inflation and a stable ISK are the main reasons for this low inflation rate in spite of the hefty wage increases negotiated in the domestic labour market.
For the near term, the outlook is for inflation to rise somewhat in excess of the CBI’s February forecast. We expect inflation to rise in the near future and slightly exceed the CBI’s inflation target in 2016. Our forecast and the CBI’s are alike in some respects, however. For instance, we both expect inflation to gain momentum this year and then settle close to target next year. The difference is, though, that the CBI expects this to happen more slowly and to a lesser degree than we do. According to the last minutes, the MPC considers the uncertainty in the CBI’s inflation forecast to be tilted to the upside.
In terms of twelve-month inflation and the CBI’s key interest rate – the rate on seven-day term deposits – the CBI’s real rate is now 3.7% and is therefore unchanged since the February interest rate decision. It has declined since November, however, when it measured 4.0%. Until then it had risen sharply since the beginning of 2012, when it was negative.
2014 GDP growth in line with CBI forecast
MPC unanimously in favour of unchanged policy rate
Growing concern about wage settlement risk
The minutes of the MPC’s last meeting indicate that members’ concerns about upcoming wage agreements had escalated since the December meeting. Members were convinced 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 of relatively moderate three-year agreements.
According to the minutes, members believed 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.