Policy rate unchanged, as forecasted

The Central Bank (CBI) Monetary Policy Committee (MPC) has decided to keep the policy rate unchanged, in line with our forecast and others. The grounds for the decision were as we had expected: that the MPC considers 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. 

MPC statement: no big news

On the whole, today’s MPC statement contained little that was new and different. The tone of the statement is the same as in February, and the latter half of it is all but a verbatim reproduction of the February statement. As before, the Committee points out that the outlook for the labour market is highly uncertain and that there are signs of strong GDP growth in the near future. For this reason, the Committee considers it appropriate, as before, to wait until the economic situation has become clearer, particularly as regards wage developments. 

In today’s statement, the Committee points out that inflation expectations have risen again after declining at the beginning of the year, possibly reflecting the expectation that upcoming wage settlements will not be in line with the inflation target. 

The closing section of the statement is exactly the same as in the February statement: “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. Large pay increases and strong growth in demand could undermine the recently achieved price stability, however, and require that interest rates be raised again.” The forward guidance implied here is neutral, in our opinion, in that it gives no indication of whether the MPC considers it likelier that the policy rate will move in one direction rather than the other.

At the press conference on today’s decision, the Governor stated that a number of unexpected developments could emerge between now and the MPC’s next meeting and change the picture markedly. For instance, wage settlements could make a significant impact on the Committee’s next decision. As a result, he said that the forward guidance in the statement should not be interpreted too literally. 

Year-2014 GDP growth in line with CBI forecast

The MPC points out that, according to newly published preliminary figures from Statistics Iceland (SI), last year’s GDP growth was in line with the CBI’s most recent macroeconomic forecast, published concurrent with the 4 February interest rate decision. The SI figures indicate that GDP growth was 1.9%, whereas the CBI had forecast it at 2.0%. The new SI figures confirm that the earlier numbers were underestimated. The CBI forecasts GDP growth at 4.2% in 2015 and 2.8% in 2016. 

At today’s press conference, the Governor said that he expects last year’s GDP growth figures to be revised upwards. He said this in response to questions on last year’s labour productivity growth, which was flat, according to current statistics on GDP growth and labour use. He added that if the figures prove correct, zero productivity growth in 2014 was cause for concern. However, the low real exchange rate had caused a shift of labour to lower-productivity sectors such as tourism, which could explain the numbers to some extent. 

Our forecast of an unchanged policy rate in 2015 remains unchanged

The next interest rate decision date is 13 May. The interval between decisions is relatively long this time, and it is quite possible that wage agreements will have been finalised by then. As before, we expect the MPC to hold policy rate unchanged through this year. If the aforementioned wage settlement risk materialises, however, it can be assumed that the MPC will respond with a rate hike. 

We still expect the MPC to respond to rising inflation, a growing output gap, and an increasingly accommodative monetary stance by raising the policy rate by 0.75 percentage points in 2016.