Íslandsbanki forecasts rate hike as inflation expectations fail to fall

Íslandsbanki’s analysis division forecasts a 0.25 percentage point increase in interest rates next Wednesday, mbl.is reported. The bank’s chief economist, Jón Bjarki Bentsson, says neither inflation nor inflation expectations have improved since May.

“In May, the Monetary Policy Committee said it was prepared to tighten monetary policy further if necessary to bring inflation and inflation expectations under control. Neither has improved since then,” Jón Bjarki said.

He said inflation appeared likely to prove more persistent this year than the Central Bank had expected. The latest measurements also showed that inflation expectations were not falling and were even beginning to rise according to some measures.

Jón Bjarki said the economy was cooling, with clear signs of this in the labour market, the housing market and economic activity. However, he said there was no recession and that the Monetary Policy Committee might conclude that the economy could withstand higher interest rates without suffering a significant setback overall.

Íslandsbanki’s baseline forecast is for interest rates to remain unchanged after next week’s increase until next spring. Jón Bjarki said the uncertainty nevertheless pointed more towards the need for further rate increases.

If the increase goes ahead, the level of monetary restraint will be greater than it was in May, when the committee considered it too low and said action was needed. Jón Bjarki said he hoped the two increases together would bring monetary restraint back to the level seen earlier in the year.

He then expected inflationary pressure to continue easing, allowing the committee to wait before beginning to cut rates later in the winter.

Jón Bjarki said the total solar eclipse on 12 August was unlikely to affect the committee’s decision. It could temporarily increase inflationary pressure in August through airfares, hotel accommodation and restaurant prices, he said, but the effect would reverse in September.

The August inflation measurement will also not be released until several days after the interest rate decision, meaning the eclipse would not influence the decision itself.