Policy rate hike in line with forecasts
The big news in today’s MPC statement is that the tone is milder as regards monetary tightening further ahead, and the forward guidance provided – which until today was strongly in the direction of a rate hike – is now less unequivocal on this point. For example, the MPC’s June statement said that “it seems apparent that a sizeable rate increase will be necessary in August, followed by further rate hikes in the coming term”. Today’s statement is milder: “If inflation rises in the wake of the wage settlements, as is forecast, the MPC will have to raise interest rates still further in order to bring inflation back to target over the medium term.” This implies that the Committee is not convinced beyond doubt that inflation will rise as quickly as is assumed in the CBI’s inflation forecast, published concurrent with this morning’s interest rate decision, and that this is the reason for the less aggressive tone.
Higher inflation and weaker output growth
As expected, the inflation forecast appearing in today’s issue of Monetary Bulletin is considerably more pessimistic than the forecast published in May. The Bank now forecasts that inflation will rise to 4.0% early in 2016 and then lie in the 4.0-4.5% range for about two years before tapering off again, whereas the May forecast provided for an inflation rate of 3.0% in 2016 and 3.2% in 2017. The change is due mainly to the massive pay hikes provided for in the recent wage agreements, which are offset to an extent by a minor appreciation of the króna, favourable developments in terms of trade, weaker output growth, and a tighter monetary stance. The CBI estimates that nominal wages will increase by just over 10% this year, just over 8% next year, and about 6% in 2017.
The CBI now forecasts weaker near-term output growth than it did in May. It projects the growth rate at 4.2% in 2015 (as opposed to 4.6% in May), 3.0% in 2016 (3.4%), and 2.8% in 2017 (3.1%). The downward adjustment of the output growth forecast is due to weaker growth in investment and exports coupled with more rapid growth in imports; however, the CBI expects stronger private consumption growth as well. The composition of output growth is therefore less favourable in the new forecast than in the previous one, and growth in labour demand is weaker.