Iceland Central Bank Raises Key Interest Rate To 8.75%

Iceland’s central bank raised its key interest rate sharply at its May meeting on Wednesday to contain the risk of a wage-price spiral in the face of strong demand pressures, and the policy board hinted that further rate hikes would bring inflation back to the target range and thereby ensure a better balanced economy.

The Monetary Policy Committee of the Central Bank of Iceland, chaired by Governor Asgeir Jonsson, decided to raise the benchmark interest rate, which is the rate on seven-day term deposits, by 125 basis points to 8.75 percent.

The previous change to the rate was in March, when the policy rate was hiked by 100 basis points.

The interest rate has now reached its highest level since the global financial crisis in 2008.

The MPC also decided to increase deposit institutions’ fixed minimum reserve requirement from 1 percent to 2 percent.

Policymakers observed that inflationary pressures have risen and are well above target. Therefore, there is a greater risk that inflation will become entrenched.

In April, consumer price inflation rose to 9.9 percent from 9.8 percent in March. The rate far exceeded the target of 2.50 percent.

The underlying inflation rate remains high, and steep price hikes can be seen in a steadily increasing share of consumption, the bank observed.

The central bank said inflation is expected to be higher in 2023 and 2024 than previously estimated.

Further, the MPC said economic growth is expected to come in at 4.8 percent this year instead of the 2.6 projected in February.

More robust activity is likely in the tourism industry this year, due to expectations of stronger domestic demand.

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