Iceland’s central bank continued its aggressive pace of monetary easing by cutting its interest rates for the fourth time this year and the ninth time in the last 12 months as it slashed its growth forecast for this year, mainly because the number of tourists visits are expected to plunge 80 percent.
The Central Bank of Iceland’s (CBI) monetary policy committee cut its key interest rate, the 7-day deposit rate, by another 75 basis points to 1.0 percent and has now cut it 200 basis points this year following cuts in February and two cuts at emergency policy meetings in March.
Since May 2019 when the outlook for the North Atlantic island darkened, CBI has cut its key rate by 3.50 percentage points.
“The MPC will continue to monitor economic developments and will use the tools at its disposal to support the domestic economy and ensure that the more accommodative monetary stance is transmitted normally to households and businesses,” CBI said.
CBI added it had stopped offering one-month deposits, saying this would make its key rate more effective and the policy signal clearer.
CBI’s rate on overnight loans now stands at 2.75 percent, the rate on 7-day collateralised loans at 1.75 percent, the 7-day deposit rate 1.0 percent and the rate on current accounts 0.75 percent.
In addition to the rate cuts, CBI has also joined the growing number of central banks that have been purchasing government bonds to keep interest rates low to ensure its easy policy is transmitted to households and businesses as governments boost spending by issuing bonds, draining liquidity and thus threatening to put upward pressure on interest rates.
Iceland’s economy has been hit by a series of adverse events in the last year prior to the outbreak of the COVID-19 pandemic.
The tourism industry was hit by the collapse of a budget airline, the grounding of Icelandair’s Boeing Max 737 aircraft and a high exchange rate. Exports were also hit from the failure of the capelin catch from rising ocean temperatures and and production difficulties in the aluminum industry.
In an update to its economic forecast, CBI now sees gross domestic product shrinking by 8.0 percent this year, a sharp revision to the January forecast of 0.8 percent growth, with exports seen plunging 31.6 percent after falling 5.0 percent in 2019.
“The outlook is for a steep rise in unemployment, which appears set to reach 12% in Q3 and measure just under 9% for the year as a whole,” CBI said. In 2019 the unemployment rate was 3.6 percent with GDP expanding 1.9 percent.
During the second half of this year economic activity is expected to gradually normalize but CBI cautioned that uncertainty remains unusually pronounced and economic developments will depend on the path of the pandemic and the unwinding of public health measures.
Next year Iceland’s economy is seen growing 4.8 percent as exports rise 23.6 percent. In 2022 the economy is seen growing another 2.8 percent.
Iceland’s inflation rate has been below CBI’s 2.5 percent target and rose slightly to 2.2 percent in April from 2.1 percent in March.
CBI expects inflation to rise marginally in coming months due to the fall in the krona but the slack in the economy will continue to weigh on prices. Consumer prices are seen rising 2.3 percent this year, down from 3.0 percent last year, and then 1.7 percent in 2021 and 1.6 percent in 2022.
While Iceland’s krona has depreciated since the virus reached the country, the impact on inflation has been offset by a drop in oil prices along with food and commodity prices. Inflation expectations, however, are largely unchanged and anchored to the target.
“More firmly anchored inflation expectations provide monetary policy scope to respond decisively to the deteriorating economic outlook,” CBI said.
After rising in the three years from March 2015 to April 2018, the Icelandic krona has been depreciating and fell sharply in March this year. In May it has bounced back and rose further today to 142.4 against the U.S. dollar, but remains down 15 percent this year.
The Central Bank of Iceland issued the following statement:
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