The decision was in line with most published forecasts, including our own. Most market agents participating in surveys conducted by Iceland Financial News, Innherji, and the CBI itself expected a 0.5-point rate cut as well. The tone in the MPC’s statement was relatively guarded, however, and the Committee clearly wants to maintain some cushion as regards lowering the real policy rate.

The highlights from the MPC statement are as follows:

• For the first time, the statement specifies that the decision was unanimous. This has not been done heretofore, but at the press conference, CBI officials stated that the change was permanent, as it was conducive to more transparent monetary policy.
• Inflation has continued to fall and was down to 4.6% in January. Underlying inflation has eased as well and is at its lowest in three years.
• The outlook is for continued disinflation in coming months.
• Demand growth has subsided in line with a tight monetary stance, and the positive output gap in the economy is narrowing.
• Housing market activity has eased, and house price inflation has lost pace.
• There are signs that economic activity is stronger than preliminary national accounts figures imply, however, and wage costs continue to rise.

Steady GDP growth and declining inflation

At the press conference following the interest rate decision, CBI officials discussed the new Monetary Bulletin, which contains the CBI’s updated macroeconomic forecast. According to that forecast, GDP growth is projected to gain pace steadily over the next three years or so. The CBI also expects year-2025 growth to be somewhat weaker (1.6%) than in its last forecast. Offsetting this is the forecast of markedly stronger growth in 2026 (2.6% instead of 2.3%) and 2027 (3.0% instead of 2.7%). The CBI’s output growth forecast is similar to our own most recent projections. As we see it, the difference lies in a stronger impact of data centre development on investment, imports, and the current account balance in 2025. Furthermore, the bank projects that a small slack in output will open up in 2025 and that economic activity will realign with capacity thereafter.

The CBI assumes a larger year-2025 current account deficit than we do but expects the balance to improve thereafter. At the press conference, it emerged that the aforementioned investment in data centres would be financed and carried out by non-resident investors. As a result, the project would entail only limited foreign currency flows, and thus there was less reason to expect this year’s current account deficit to put downward pressure on the ISK.

The CBI’s new inflation forecast is marginally more pessimistic than its predecessor, which dates from November. It is well in line with our more recent forecast of near-term developments, though. The CBI projects that inflation will fall to 3.4% by Q4/2025 and then reach the 2.5% inflation target in H2/2026, whereas we expect inflation to sit stubbornly at a level just above target in the next few years. On the other hand, CBI officials mentioned at the press conference that bringing inflation past the finish line could prove more difficult than was assumed in the forecast.

At the press conference, there was lively discussion of various uncertainties that could affect the outlook for the coming term:

• Public finances: When questioned, CBI officials stated that public finances would be a major determinant of developments in the period ahead. They would give particular attention to the Government’s forthcoming fiscal strategy plan, to be released later this winter. Emphasis on economic stability and the introduction of a spending rule for the Government were positive signs.
• Trade war: Like us, CBI officials are quite concerned about the potential repercussions of a tit-for-tat tariff war that could escalate in coming months. They pointed out that putting up roadblocks to world trade in the form of tariffs or non-tariff trade barriers had demonstrably made a negative impact on both inflation and economic developments in the past.
• Labour market dispute with teachers: CBI officials reiterated that last year’s collective bargaining agreements with the majority of the public sector had been a positive step towards greater price stability. As a result, there was much at stake in sticking to that path through the currently ongoing dispute. The CBI’s forecast assumed that wage agreements would hold throughout the forecast horizon, although CBI spokespersons did not express a specific opinion on the current dispute.

Further policy rate cuts likely this year

The forward guidance from the MPC is slightly changed from the November statement. It reads as follows:

Although inflation has eased and inflation expectations have fallen, inflation pressures remain, which calls for a continued tight monetary stance and caution regarding decisions going forward. This is compounded by elevated global economic uncertainty.

As before, near-term monetary policy formulation will be determined by developments in economic activity, inflation, and inflation expectations.

For the sake of comparison, the November statement read as follows:

Persistent inflation and inflation expectations above target call for caution, however. As a result, it is still necessary to maintain an appropriately tight monetary stance in order to bring inflation back to target within an acceptable time frame.

As before, near-term monetary policy formulation will be determined by developments in economic activity, inflation, and inflation expectations.

We interpret the MPC’s forward guidance to mean that the Committee wants to hold the real policy rate close to its current level and that rate cuts at its upcoming meetings (March and May) will depend not least on whether inflation/inflation expectations decline in coming months. In this context, CBI officials mentioned at the press conference that the real economy was still strong, and there were few signs that they need be in any hurry to lower the real policy rate. In view of our most recent forecast of macroeconomic developments and inflation in coming quarters, we think this could mean a rate cut of 0.25 percentage points in March, and again in May.

Our policy rate forecast, which is included in our macroeconomic forecast from last week, provides for a policy rate of 6.5% at the year-end and between 5.0% and 5.5% from mid-2026 onwards.