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Macroeconomic updates - all news

28.08.2019

You shall not pass any further? 25 bps rate cut and silence of the doves

The Monetary Policy Committee (MPC) of the Central Bank of Iceland (CBI) has decided to lower the Bank’s policy rates by 0.25 percentage points, from 3.75% to 3.5%. The decision is in line with analysts’ expectations, who beforehand had all forecast that Ásgeir Jónsson, the new Governor of the CBI, would start his term off with a bang, or a rate cut in this case. As in June, the decision was rationalized by tighter monetary stance between meetings, due to falling inflation expectations, and improved inflation outlook. Thus, faster subsiding inflation and stronger anchoring of inflation expectations offset smaller economic contraction than was previously forecast.

Examining every word, phrase, and language use of the MPC is an integral part of analysts’ work. This time around, the statement is brusque and short on treats. In fact, what the statement doesn’t say is more important than what it actually does say, as the forward looking guidance has undergone significant changes, silencing the dovish tone. Of course the policy decisions “will depend on the interaction between developments in economic activity, on the one hand, and inflation and inflation expectations, on the other”, just as the earth orbits the sun, but there is not one word on the “MPC’s considerable scope to respond to the economic contraction”, as has been the previous two statements.

So we ask, is the considerable scope not so considerable after all? According to the Governor and the chief economist of the CBI, interest rates can certainly be cut further, but if wage increases or inflationary pressures exceed the bank’s expectations, the MPC may need to wait a while, or tighten the monetary stance. In other words, further rate cuts are not as certain as before.

 

Sources: CBI, Statice, Arion Research

Make Iceland Great Again

The new Monetary Bulletin which was published this morning was much more interesting read than the MPC statement. The CBI’s economic forecast has changed somewhat since May. First of all, the economic contraction in 2019 is expected to be smaller than previously thought, or 0.2% compared to 0.4% in May, despite a larger drop in tourist arrivals, and consequently a larger exports contraction than previously forecasted. The reason for the change, and the expected soft landing according to the Governor, is stronger private consumption growth and greater import contraction than previously thought. Thus, the CBI concludes that domestic demand seems to be more directed to domestic production, rather than imported goods and services.

The CBI expects GDP to contract by almost one percent in Q2. However, at the presentation this morning the chief economist acknowledged that hefty contraction in imported services, as reported by Statistics Iceland last Monday, exceeded the bank’s expectations. This raises the question whether the contraction in Q2 might be less than expected by the CBI. If that’s the case, it might push the bank’s forecast for the whole year up to zero, and perhaps into growth territory. GDP growth in 2019 could close the door on further rate cuts in the near future.

 

Source: CBI

Inflation, where art thou?

The inflation outlook has improved in recent months and various positive signs have emerged in recent months. Yearly inflation currently is at 3.1%, compared to 3.4% at the end of Q1. Core inflation has also subsided, suggesting that underlying inflation pressures have eased and that prices are simply rising less than expected a few months ago. The CBI has accordingly lowered its inflation forecast for the second time in a row.

However, the world of inflation is not a bed of roses, as domestic inflationary pressures have risen in recent months, presumably due to wage increases and more expensive imports due to the weaker ISK. The MPC is probably watching domestic inflation more closely than other inflation measures, as its development should indicate the level of tension in the domestic economy, while imported inflation is largely characterized by foreign price development and the ISK.

Inflation expectations of market participants and households took the center stage in the chief economist’s presentation this morning, unsurprisingly given the importance of inflation expectations in interest rate decisions. Historically, inflation expectations of market participants, company executives and households have been higher than the CBI’s inflation target, leading to higher rates than otherwise. While household’s inflation expectations have remain unchanged from the last MB’s publication in May, business expectations and market expectations have fallen to 3%. Long-term inflation expectations of market participants for 5 years have reached 2.5% (they expect that inflation will average 2.5% over the next 5 years), as well as their 10-year expectations, which must be considered a big achievement for the bank and the MPC.

 

Sources: Statice, Arion Research

Further rate cuts according to Taylor

With the last two interest rate cuts, the MPC has continued to follow the Taylor rule. This is clear when looking at the graph below as the actual collateralized lending rate and the rate according to the Taylor rule make an almost perfect fit. As previously state, the Taylor rule is not our official interest rate forecast, just a game of numbers while trying to gain insight into the MPC’s mentality.

Based on the CBI’s latest economic and inflation forecast, the Taylor rule suggests further rate cuts this year, approximately 50 bps. Even though the CBI’s new macroeconomic forecast assumes greater contraction in tourism this year and a slower recovery than previously projected, we still believe that the rebound forecasted for next year, and national expenditure growth, will not allow room for a 50 bps cut in the next four months. The MPC’s tone supports this view, as the dovish tone has turned neutral. If the autumn proves to be difficult for the economy, we believe 25 bps to be the medicine the MPC will subscribe.

 

Sources: CBI, Arion Research. * Real neutral interest rates are 3% until mid-2015 and get gradually lower thereafter.

Back
  • 10.11.2020

    Economic Outlook 2020-2023: Every storm runs out of rain

  • 17.12.2019

    Economic Outlook: Mild winter, cold spring

  • 13.09.2019

    Tourism in Iceland: Modest angle of attack

  • 03.09.2019

    Oops, they did it again: Statice revises GDP figures

  • 30.08.2019

    Wow, 1.4% GDP growth in Q2 without WOW

  • 28.08.2019

    You shall not pass any further? 25 bps rate cut and silence of the doves

  • 13.08.2019

    Economic Outlook: Bumpy, but passable

  • 02.07.2019

    Icelandic tourism fights back

  • 26.06.2019

    Governor‘s farewell: 25 bps rate cut

  • 03.06.2019

    Net IIP takes center stage in Q1

  • 31.05.2019

    The way it was: 1.7% GDP growth in Q1

  • 27.05.2019

    BoT: Sunshine and showers

  • 22.05.2019

    Lower rates and dovish tone

  • 10.05.2019

    Cloudy with a chance of hail according to Statistics Iceland

  • 05.04.2019

    Economic Outlook: Winter is here

  • 21.03.2019

    Few options but to keep rates unchanged

  • 08.03.2019

    The Special Reserve Requirement lowered to 0%

  • 04.03.2019

    A surprising CA surplus in Q4

  • 01.03.2019

    Still waiting for a soft landing: 4.9% GDP growth in 2018

  • 25.02.2019

    Deficit is coming

  • 06.02.2019

    The doves unsurprisingly win the hawks – unchanged interest rates

  • 24.01.2019

    The Icelandic Housing Market: Finally levelling off

  • 03.01.2019

    The Beat Goes On: 2018 in Review

  • 12.12.2018

    Unchanged interest rates – the króna takes center stage

  • 07.12.2018

    GDP growth in Q3: Well hello private consumption!

  • 04.12.2018

    (Almost) a record surplus

  • 07.11.2018

    Hawkish tone decorated with dove feathers

  • 31.10.2018

    Economic Outlook: Soft(ish) landing

  • 02.10.2018

    Tourism in Iceland: Soft landing or a belly flop?

  • 07.09.2018

    Staggering growth in the second quarter

  • 04.09.2018

    The surplus shrinks while the external position soars

  • 31.08.2018

    Balance of trade Q2: The surplus decreases, again

  • 29.08.2018

    Unchanged interest rates: MPC flexes muscles

  • 02.08.2018

    Economic Outlook: Summer is Fading

  • 03.07.2018

    Never Too Old to Learn - Soft Landing Ahead

  • 11.06.2018

    Strong GDP growth in Q1 not enough to change rates

  • 05.06.2018

    Current account in Q1: Small, smaller, smallest

  • 01.06.2018

    Balance of trade in Q1: The incredible shrinking surplus

  • 18.05.2018

    Similar statements, same interest rates

  • 17.05.2018

    This is why we expect the króna to depreciate

  • 11.05.2018

    Winter rates will not let it go

  • 23.04.2018

    Economic Outlook: Caution, fragile!

  • 14.03.2018

    Unchanged interest rates, unchanged reserve requirement

  • 09.03.2018

    3.6% GDP growth in 2017: No cause to change rates

  • 06.03.2018

    Honey, I shrunk the current account surplus

  • 02.03.2018

    Trade in services: False alarm?

  • 07.02.2018

    Unchanged interest rates – No hawks in sight

  • 05.02.2018

    The Icelandic Housing Market: On the mend

  • 19.01.2018

    2017 Q4: Icelanders meet expectations, tourists do not

  • 15.11.2017

    Hurdle on the path to lower interest rates

  • 14.11.2017

    Economic Outlook: Too good to be true?

  • 04.10.2017

    Unexpected interest rate cut – Iceland low interest rate country?

  • 18.09.2017

    Tourism in Iceland: Here to stay?

  • 11.09.2017

    Private consumption joined the party – 3.4% GDP growth in Q2

  • 05.09.2017

    Strong króna reduces the current account surplus

  • 23.08.2017

    Interest rates unchanged – rate cuts put on hold

  • 10.08.2017

    Economic Outlook: Soft landing ahead?

  • 18.07.2017

    Payment card turnover increases by 12.2% in June

  • 26.06.2017

    External trade in a tiny economy

  • 15.06.2017

    The Central Bank's summer gift: Interest rate cut

  • 08.06.2017

    Private consumption and external trade fuel 5% economic growth

  • 30.05.2017

    Five reasons why the Icelandic króna is too strong

  • 17.05.2017

    Rising sun brings rate cuts

  • 25.04.2017

    Summary on the Icelandic stock market, dividends and interest in the market

  • 31.03.2017

    Economic Outlook 2017-2019

  • 15.03.2017

    Unchanged interest rates – will spring bring rate cuts?

  • 13.03.2017

    Further steps taken towards capital account liberalization

  • 09.03.2017

    GDP growth 11.3% in fourth quarter of 2016

  • 08.03.2017

    Are there grounds for further strengthening of the ISK?

  • 03.03.2017

    Current account surplus 8% of GDP in 2016

  • 28.02.2017

    Inflation: Continued tug of war between exchange rate and housing prices

  • 08.02.2017

    Unchanged interest rates and inflation near target rate

  • 07.02.2017

    The Icelandic Housing Market: Still in search of equilibrium

  • 01.02.2017

    The Króna depreciates in the first month of the year

  • 01.02.2017

    Strong labor market in December and 2016

  • 12.01.2017

    New majority government formed

  • 29.12.2016

    Third quarter GDP growth in double digits

  • 29.12.2016

    Tourists reduce spending amidst appreciating króna

  • 29.12.2016

    Housing prices keep rising

  • 29.12.2016

    Allowances to foreign investment of pension funds increased

  • 09.11.2016

    The times they are a changin’ – parliamentary elections 2016

  • 01.11.2016

    Arion Research Economic Outlook 2016-2019

  • 20.09.2016

    Tourism in Iceland: Dreamland or Devil’s Island?

 

Icelandic Economic Update 2016

  • Icelandic Economic Update December 2016

  • Icelandic Economic Update November 2016

  • Icelandic Economic Update October 2016

  • Icelandic Economic Update September 2016

  • Icelandic Economic Update August 2016

  • Icelandic Economic Update July 2016

  • Icelandic Economic Update June 2016

  • Icelandic Economic Update May 2016

  • Icelandic Economic Update April 2016

  • Icelandic Economic Update February 2016

  • Icelandic Economic Update January 2016

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