Today’s MPC statement is brief and the forward guidance neutral. It notes that economic activity was stronger than expected in 2020 and that indicators suggest a continuing recovery in 2021 to date. But uncertainty is still pronounced, and the COVID-19 pandemic and the vaccine roll-out in Iceland and abroad will be the main drivers of events to come.

The MPC is of the view that inflation will start to subside this spring, even though the near-term outlook has deteriorated since February, in part because of the recent spike in oil and commodity prices stemming from pandemic-related disruptions in production. Inflation expectations have risen, although it is too soon to determine whether they have become less firmly anchored to the target.

The forward guidance from the MPC is repeated all but verbatim from the February statement:

“The MPC will apply the tools at its disposal to support the domestic economy and ensure that inflation eases back to the target within an acceptable time frame.”

In other words, it is neutral, as before, and gives no particular indication of whether the next interest rate change will be upwards or downwards, how long such a change might be in coming.

At the press conference following the publication of the decision, we asked Governor Ásgeir Jónsson about the CBI’s foreign exchange market intervention policy, in view of the marked appreciation of the ISK in recent weeks. At the close of business yesterday, one euro cost ISK 148.3, and a US dollar cost ISK 124.8 – the strongest the ISK has been against these two currencies in over a year. Ásgeir said he considered the intervention policy to have been successful, noting that the regular sale of foreign currency into the market had fostered greater stability and reduced uncertainty at a time when foreign exchange inflows from tourism had slowed to a trickle. We agree with this view. On the other hand, Ásgeir pointed out that the policy on regular currency sales was announced at each month-end, and if the trend of the past few weeks continues, reviewing the regular sales programme would be a possibility, probably with an eye to scaling it down. We think it highly likely that the CBI will halt its regular currency sales at the end of this month and will not reinstate the programme unless the ISK comes under severe pressure in the next few months.

Both Ásgeir and Deputy Governor Rannveig Sigurðardóttir were asked whether the foreseeable slack in fiscal policy might lead to CBI interest rate hikes. They answered that economic policy had generally been successful during the battle with the Corona Crisis, as could be seen, for instance, in the smaller-than-expected economic contraction in 2020; however, if post-pandemic fiscal policy was expansionary, the CBI would need to tighten the monetary stance. They said, though, that this was hardly in the picture in the immediate future. In an interview with visir.is, Ásgeir stated more decisively that he considered a policy rate hike unlikely in 2021 if the CBI’s forecasts materialise. He also noted that the bank had other monetary policy instruments at its disposal in response to a narrowing slack in output. We choose to interpret the Governor’s statements (those made today and in the recent past) on the need for a tighter monetary stance to offset accommodative fiscal policy as a message to the next Government, which will presumably take office late this year, after the coming Parliamentary elections.

In that context, Ásgeir reiterated at this morning’s press conference that the CBI’s FX market intervention had reduced the money supply, and that this was in part why there was scope to provide the Treasury with ISK in exchange for a portion of the foreign currency it holds on deposit with the CBI. At the end of February, the Treasury had an FX balance equivalent to ISK 323bn, and it will probably use some of it to finance deficit operations later this year. But the Treasury’s ISK deposits are also hefty at the moment, totalling ISK 119bn, according to the most recent figures. With those funds to draw on, the Treasury can presumably wait a while before selling FX assets to finance the deficit.

This morning’s interest rate decision is in line with our expectations, and the MPC statement does not suggest that rates will be changed in the near future. The tone of the press conference and the Governor’s statements to the media are in the same vein. In our most recent policy rate forecast, we projected that the CBI would hold rates unchanged through the end of the year, and nothing we have learned today has changed our opinion.