Policy rate unchanged – in line with forecasts

The Central Bank (CBI) Monetary Policy Committee (MPC) has decided to keep the policy rate unchanged, in line with our forecast. The main rationale for the decision is the short-term inflation outlook, which has improved since the November forecast. In addition, a stronger króna and more favourable global price developments have provided the scope to raise interest rates more slowly than was previously considered necessary. 

Softer monetary tightening tone

The MPC has softened its tone since early November. In today’s statement, the Committee says that “according to the Bank’s November forecast, a tighter monetary stance will probably be needed in the coming term, in view of growing domestic inflationary pressures”, whereas in November it stated outright that the monetary stance would be tightened in the coming term. In this context, it should be noted that, according to our forecast, inflation will be well below the CBI’s inflation forecast in Q4/2015 and the first half of 2016. 

Reserve requirements reduced before the year-end

It is notable that the MPC has decided to lower reserve requirements from 4.0% to 2.5% effective 21 December, so as to mitigate the effect of the stability contributions to be paid by the old banks in coming weeks, which represents a reduction of financial system liquidity. Furthermore, the MPC plans to lower reserve requirement to 2.0% after the auction of offshore krónur, to be held in the next few months. This is an unexpected turn – at this point in time, at least – and is the equivalent of monetary easing, as reserve requirements were raised from 2.0% to 4.0% in September.

At this morning’s press conference, the Governor of the Central Bank said that lowering reserve requirements in connection with the offshore ISK auction and the settlement of the old banks’ estates had always been part of the plan. The impact of settling the old banks’ estates will probably be stronger than was expected last autumn, and the stability contributions will probably be paid sooner than previously anticipated. The Governor said that raising reserve requirements had achieved the desired results and that the banks had responded in line with expectations. Actually, the Governor implied that the impact had been greater than the CBI had expected, which may explain in part the short duration of the higher reserve requirements. Furthermore, the Governor said that the improvement in the inflation outlook was primarily good news and did not give cause to revise the bank’s forecasting methods. 

We expect the policy rate to remain unchanged through mid-2016. 

As we stated in our most recent policy rate forecast, we expect the policy rate to remain unchanged well into 2016 but to rise by 0.5 percentage points over the year as a whole. Added to this will be the equivalent of a 0.75-point rate rise in the effective policy rate as the banks’ funding shifts increasingly to short-term borrowing from the CBI when the failed banks’ estates are settled and offshore krónur exit from the economy, reducing the amount of liquidity in circulation.