Central bank warns high wage rises could undermine inflation target

Iceland’s central bank leaders say they hope recently extended wage agreements will hold, warning that continued excessive pay rises could make it harder to bring inflation down. They spoke at a briefing after the bank’s monetary policy committee decided to keep interest rates unchanged, mbl.is reported.

Governor Ásgeir Jónsson said uncertainty in the labour market had eased somewhat after the agreements were extended. He said the bank believed public charges would rise in line with its 2.5 per cent inflation target and that it took the finance minister at his word that fiscal policy would be restrained.

“If we have a 2.5 per cent inflation target, it is very difficult to achieve it if the public sector raises charges by more than 2.5 per cent and wages are rising by six to eight per cent,” Jónsson said. “It is practically impossible. Anyone can work that out in Excel or on paper.”

Jónsson said wages in Iceland had risen much more than abroad and were now among the highest in Europe when payroll-related charges were included. “It is not as if we in Iceland have invented some kind of alchemy machine that lets us follow a different path from other countries,” he said.

The current wage agreements provide for pay rises of 3.5 to 4 per cent at the turn of the year, which Jónsson described as substantial. He said lower inflation and interest rates could be the greatest benefit for households.

Deputy Governor for Monetary Policy Þórarinn G. Pétursson said the bank had called for responsibility for meeting the inflation target to be shared beyond the central bank. While he welcomed the plan to limit increases in public charges to 2.5 per cent, he said it was hard to see how that could be sustained if wages, a key component of production costs, continued to rise considerably faster.

He added that it would be difficult for companies and the public sector to keep the prices of their goods and services rising by 2.5 per cent if wage costs continued to increase well above that level.