sedlabanki

Iceland’s central bank has just cut its interest rates by 25bp, leaving the key current account rate at 3.25 per cent. The Bank hasn’t stopped cutting since the financial crisis, though this is the smallest cut since 2002. Previous cuts have been monthly, and mostly half a percentage point (see chart).

The tiny island-state’s economy appears in relatively good shape. Inflation has fallen below the target of 2.5 per cent, and inflation expectations, which were nearing double digits, have fallen below 5 per cent. Indeed, with inflation at just 1.8 per cent, one might wonder why rates have been cut at all. According to the Bank, temporary factors were at play in pushing down January’s inflation:

One-off factors added to the seasonal drop in January. Favourable exchange rate developments over the past year, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation.

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Declining inflation expectations and a strengthening currency have prompted another substantial 75bp cut to Iceland’s key rates. The country has not stopped cutting since the financial crisis (see chart). No doubt the decision was supported by expectations of Fed easing, and the lower dollar that will likely follow.

Key rates are left as follows:

  • deposit rate (current account rate) will be 4 per cent
  • maximum bid rate for 28-day certificates of deposit (CDs) will be 5.25 per cent
  • seven-day collateralised lending rate will be 5.5 per cent
  • overnight lending rate will be 7 per cent.

Iceland’s central bank has also announced a revision to its strategy to lift capital controls. Read more