Iceland cuts rate 9th time as economy seen shrinking

May 20, 2020

By CentralBankNews.info

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:

“The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to lower the Bank’s interest rates by 0.75 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 1%.
The Committee has also decided to stop offering one-month term deposits. This entails that the Bank’s key rate will be more effective and the Bank’s policy rate signal clearer. Other things being equal, this measure should increase liquidity in circulation and further strengthen monetary policy transmission.
According to the Bank’s new macroeconomic forecast, published in the May issue of Monetary Bulletin, the outlook is for an 8% contraction in GDP in 2020. The predominant factor underlying this forecast is a more than 80% decline in tourist visits to Iceland. 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. According to the Bank’s forecast, economic activity will gradually normalise starting in H2/2020. GDP growth is forecast at nearly 5% in 2021. Uncertainty is unusually pronounced, however, and economic developments will depend on the path the pandemic takes and the progress made in unwinding the associated public health measures.
Inflation measured 2.2% in April and has been below the Bank’s inflation target since December 2019. The króna has depreciated since the pandemic reached Iceland, but this is offset by a steep decline in oil prices, as well as a decline in food and commodity prices. Furthermore, inflation expectations are broadly unchanged, and they appear to be firmly anchored to the target. According to the Bank’s forecast, inflation will rise marginally in coming months due to exchange rate pass-through from the depreciation of the króna. The increased slack in the economy will weigh heavier as 2020 progresses, however, and the outlook is for inflation to measure below 2% in the latter half of the forecast horizon.
More firmly anchored inflation expectations provide monetary policy the scope to respond decisively to the deteriorating economic outlook. Lower interest rates, together with other actions taken by the Bank, will support the economic recovery and contribute to a more rapid recovery than would otherwise occur. Fiscal policy measures have pulled in the same direction.
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.”

 


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