Key interest rate 8.75% after a 1.25 percentage point hike this morning

The Monetary Policy Committee (MPC) of the Central Bank of Iceland raises the Bank’s interest rates by 1.25 percentage points. The Bank’s key interest rate will therefore be 8.75%.

At the same time the Committee has also decided to increase deposit institutions’ fixed minimum reserve requirement from 1% to 2%, is reported in an announcement from the bank this morning.

“Economic activity has been strong in 2023 to date, and the Central Bank’s new macroeconomic forecast assumes that GDP growth will measure 4.8% this year instead of the 2.6% projected in February. This is due in large part to the prospect of stronger growth in domestic demand, although the outlook is also for more robust activity in the tourism industry.”

It is noted that underlying inflation continues to rise and that large price increases are being detected in an increasingly large part of the consumer basket. It looks as if there is considerably more inflationary pressure this year and next year than anticipated. In April inflation measured 9.9%, which is slightly higher than March and the outlook is for stronger inflationary pressures in 2023 and 2024 than had been predicted.

“Therefore, there is a greater risk that inflation will become entrenched. In light of this, it is necessary to tighten the monetary stance still further. It is especially important to prevent a wage-price spiral, particularly in view of the strong demand pressures in the economy and how soon the next round of wage negotiations will begin. Therefore, the outlook is for further rate hikes in order to ensure a better balanced economy and bring inflation back to target.”

Central Bank governor Ásgeir Jónsson said at the briefing of the Icelandic Central Bank this morning that the national policy has not been reached to bring down the country’s inflation, citing, among other things, wage increases and last semester’s wage negotiations. If the labour market refuses to take responsibility, then the policy instrument needs to be applied more firmly than otherwise.