Iceland cuts rate 50 bps as economic outlook worsens

23rd May 2019 Off By binary

By CentralBankNews.info

Iceland’s central bank cut its key interest rates, the 7-day deposit rate, by 50 basis points to 4.0 percent, sharply reversing its tightening bias from March, due to a swift deterioration in the economic growth outlook from a drop in tourism and exports of marine products.
It is the first rate cut by the Central Bank of Iceland (CBI) since October 2017 and the first change in rates since a rate hike in November 2018.
In it latest monetary bulletin, CBI slashed its growth forecast for 2019 to a drop in output of 0.4 percent from a previous forecast of 1.8 percent growth and 2018’s robust growth of 4.6 percent when a boom in tourism helped the country emerge from the ravages of the 2008 financial crises.
The central bank also lowered its outlook for growth in 2020 to 2.4 percent from a previous 2.8 percent but retained its 2021 forecast of 2.6 percent.
“But the outlook has clouded over,” CBI said in its bulletin, noting the collapse of budget airline WOW in March would lead to a further drop in tourist arrivals.
WOW already began downsizing its fleet of aircraft at the start of this year and the outlook is for tourist arrivals to decline by 10.5 percent this year from last year before slowly rising again in 2020 to 2.3 million, largely the same as in 2018.
“The outlook is highly uncertain, however, and the possibly of a deeper contraction and slower recovery cannot be excluded,” CBI said, adding tourism could be affected by the high exchange rate of the krona, uncertainty surrounding Icelandair’s use of its new Boeing 737 Max jets this summer and any impact from the recent temporary strikes.
In a second blow to its economy, Iceland’s exports have been hit by a collapse of the fishing of capelin, a small fish that grazes on plankton and krill at the edge of the ice shelf.
After the collapse of herring stocks in the late 1960s, Icelandic fishermen turned to capelin but for the first time since 1963 there is no catch expected this year, a devastating blow to local fishing villages and a hit to exports and a 0.4 percentage point loss to the country’s gross domestic product.
Although CBI expects the capelin catch to resume in 2020, it added this “assumption is highly uncertain, not least if rising ocean temperatures cause caplin spawning grounds to move outside Iceland’s fishing waters,” which would mean the growth outlook for the next 2 years could turn out to be overly optimistic.
The hit to economic activity will also create economic slack and curb inflation.
CBI now expects consumer price inflation this year of 3.2 percent, down from February’s forecast of 3.5 percent, 2.6 percent in 2020, down from 2.8 percent, and 2.2 percent in 2021, down from 2.4 percent.
Boosted by tourism and high wages, Iceland’s inflation rate rose to 3.7 percent in December last year, well above the bank’s 2.50 percent target, and in its previous policy statement from March CBI said inflation expectations topped its target and this could cal for a tighter monetary stance in coming months.
In April’ Iceland’s inflation rate rose to 3.3 percent from 2.9 percent in March while GDP grew 4.0 percent in the 2018 fourth quarter year-on-year, up from 2.5 percent in the third quarter.

The Central Bank of Iceland issued the following statement:

“The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to lower the Bank’s interest rates by 0.5 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 4%.
According to the Bank’s new macroeconomic forecast, published in the May issue of Monetary Bulletin, the GDP growth outlook has changed markedly since the Bank’s last forecast. Output is now forecast to contract by 0.4% this year instead of rising by 1.8%, as was forecast in February. This deterioration in the outlook is due primarily to a contraction in tourism and reduced marine product exports because of the capelin catch failure. As a result, the positive output gap will close and a slack emerge in the near future.
Inflation measured 3.1% in Q1/2019 but rose to 3.3% in April. Underlying inflation has developed in broadly the same manner, and the difference between measures of inflation including and excluding housing is at its smallest since autumn 2013. The króna has held relatively stable in 2019 to date, and the inflationary effects of the autumn 2018 depreciation have thus far been smaller than anticipated. The deterioration in the economic outlook has caused the inflation outlook to change markedly in a short period of time, and the Bank’s forecast assumes that inflation will peak at 3.4% in mid-2019 and then ease back to the target by mid-2020.
Although the recently finalised private sector wage agreements provide for sizeable pay increases, the outcome was better in line with the inflation target than was widely expected. Inflation expectations have therefore moderated again after having risen markedly over the course of 2018. Market agents’ long-term inflation expectations have now eased back below 3%.
Although the economic contraction will be challenging for households and businesses, the economy is much more resilient than before. Furthermore, monetary policy has considerable scope to respond to the contraction, particularly if inflation and inflation expectations remain close to the target, as is currently envisioned. Moreover, the Government’s proposed fiscal measures in connection with wage settlements will pull in the same direction.
Near-term monetary policy decisions will depend on the interaction between developments in economic activity, on the one hand, and inflation and inflation expectations, on the other.
The interest rates will be as follows:

1. Overnight loans 5.75%
2. Collateralised loans 4.75%
3. Seven-day term deposits 4.00%
4. Current accounts 3.75%
5. Minimum required reserves, average maintenance 3.75%
6. Minimum required reserves, fixed requirement 0.00%”
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