Governor Optimistic About Iceland’s Economy After Wage Deals

Central Bank Ásgeir Jónsson seðlabankastjóri

The recent wage agreements reflect a unified effort, with all parties seemingly unified towards a common goal, the governor of the Central Bank told RÚV this morning. He anticipates a decline in inflation, potentially setting the stage for lower interest rates.

Uncertainty regarding global economic outlooks

This morning, the Central Bank’s Financial Stability Committee presented its semi-annual Financial Stability Report, which, as noted by the Central Bank’s website, presents “an overview of the position of the financial system, its strengths and potential weaknesses, and the macroeconomic and operational risks it may face.”

This newest report indicates, among other things, that interest rates may have peaked in light of the tightening of monetary policy over recent months. There remains, however, significant uncertainty regarding global economic outlooks, not least because of the armed conflicts in Gaza and Ukraine. Furthermore, there has been a slowdown in the growth of the Icelandic tourism sector, with signs that tourists are staying in the country for shorter periods and spending less. The geological unrest on the Reykjanes Peninsula has also had negative effects. Nonetheless, the position of the major commercial banks is strong, and their capital ratios are healthy.

“Headed in the right direction”

In an interview with RÚV this morning, Ásgeir Jónsson, the governor of the Central Bank, stated that things were headed in the right direction:

“In my mind, everything is moving in the right direction. There has been significant economic growth; the Icelandic economy has grown by 20% over three years, from 2021 to 2023, which is a tremendous growth rate. Our goal at the Central Bank in this regard was to keep debt growth low. We wanted to ensure that this boom did not lead to the financial system overreaching or to seeing significant debt accumulation, and we have succeeded,” Ásgeir remarked.

Upbeat about the wage negotiations

As recently reported, collective bargaining agreements have been negotiated with a majority of wage earners in the general market, with the primary goal of reducing inflation and, thereby, interest rates. Ásgeir is sanguine about these agreements:

“I just want to say that these agreements are very positive. We haven’t fully overviewed them yet; they are complex and involve many parties, including the Treasury, and they are not yet concluded. I believe negotiations with the largest union are still pending, as well as various special unions. But the approach has been correct.”

The governor also stated that the agreements proved that everyone was aligned in their efforts, and now it was up to the Central Bank to ensure inflation decreased and the agreements delivered purchasing power to the public. He added that he could not comment on the interest rate as the monetary policy committee was yet to meet; the day of the next interest rate decision is just over a week away. As noted by RÚV, the analysis division of Íslandsbanki Banks predicts a 0.25% point decrease in interest rates, with others having similar expectations. The governor understands these expectations well:

“I understand this well because what we are seeing now is that inflation has decreased – it’s on the right track. The Central Bank predicts it will continue to fall. Likewise, we are seeing the real economy responding, the overheating is cooling down, and a decrease in loan demand. We are witnessing a decline in private consumption, investment, and other things, which suggests that we can start to ease up on the tightening of interest rates.”

Central Bank Announces 14th Consecutive Rate Hike

Central Bank

The Monetary Policy Committee of the Central Bank of Iceland announced this morning that it would be raising the policy rate by 0.50%. This is the fourteenth rate hike in a row, with the bank’s main interest rate currently sitting at 9.25%.

Inflation subsided slightly

In its fourteenth consecutive rate hike, the Central Bank announced this morning that it would be raising the key interest rate by 0.50%, bringing the bank’s main interest rate to 9.25%. The previous increase of 1.25% was announced in May.

According to the announcement, inflation has subsided somewhat – down to 7.6% in July – since the last interest rate decision. The short-term inflation outlook has improved. However, inflation expectations are still above the bank’s target of 2.5% and there is a risk that it will prove persistent. “In light of this, it is necessary to further tighten the reins of monetary policy. In particular, it is important to prevent the interaction of rising wages and prices.”

The announcement also notes that the housing component’s contribution to inflation has decreased, international price increases have decreased, and the exchange rate of the króna has increased. However, domestic price increases have proven to be persistent and are still on a broad basis. Underlying inflation has, therefore, decreased more slowly than measured inflation; it was 6.7% in July.

Governor calls on the government to exercise “prudence”

In a press conference following the announcement, Þórarinn G. Pétursson, Chief Economist at the Central Bank, noted that the number of jobs is increasing rapidly; during the second quarter of the year, the unemployment rate was 2.8%, the lowest since the fall of 2017. The number of companies in search of employees is decreasing, Þórarinn noted, although the percentage was still well above the historical average.

Þórarinn also noted that economic growth was lower than the Central Bank expected in May. The same held for private consumption: 5% when the Central Bank had forecast expected almost 7%. The difference is mainly in Icelanders’ spending abroad, which turned out to be less significant than expected.

Governor of the Central Bank Ásgeir Jónsson emphasised that a fifty-point hike in the interest rate was significant. The economy remained strained, with wages witnessing a 10% rise year-on-year and notable surges in domestic product prices. According to Ásgeir, the Central Bank has already made substantial interest rate adjustments, and its impact will be closely monitored. The upcoming Monetary Policy Committee meeting is just around the corner.

Regarding next year’s budget proposal, Ásgeir mentioned that the Central Bank did not have specific requests. However, they hope the government exercises utmost prudence in its operations.

Read More: A Króna for Your Thoughts (Interview with Governor of the Central Bank Ásgeir Jónsson)

Central Bank Raises Key Interest Rates by 1.25%

Central Bank

The Monetary Policy Committee of the Central Bank of Iceland raised the policy rate this morning by 1.25%. This is the thirteenth rate hike in a row, with the bank’s main interest rate currently sitting at 8.75%.

Curbing inflation

In its thirteenth consecutive rate hike, the Central Bank announced this morning that it would be raising the key interest rate by 1.25%, bringing the bank’s main interest rate to 8.75%. The previous increase of 1% was announced in March.

According to the announcement, economic activity has been strong so far this year. The central bank’s latest economic forecast projects a notable increase in economic growth, expecting it to reach 4.8% for the year, a significant revision from the previous forecast of 2.6% in February. This revised projection takes into account the anticipated surge in domestic demand and the emergence of heightened activity within the tourism industry, both of which have contributed substantially to the optimistic outlook.

As noted by RÚV, the Governor of the Central Bank has emphasised the necessity of these interest rate hikes to combat inflation. Despite the twelve previous rate hikes, however, the Central Bank has not yet been able to bring inflation under control; the annual inflation rate measured 9.9% in April, well above the bank’s target of 2.5% (the annual inflation rate peaked at 10.2% in February).

The announcement notes that there is an increased likelihood that inflation will prove persistent; underlying inflation continues to increase and large price increases are measured in an increasingly large part of the consumption basket.

Read More: A Króna for Your Thoughts (Interview with Governor of the Central Bank Ásgeir Jónsson)

Governor Has Faith in the Banks’ Sense of “Social Responsibility”

Central Bank

A conversation has taken place between Iceland’s Central Bank and managers of the country’s commercial banks, the Governor of the Central Bank revealed at an open meeting before Parliament’s Economic Affairs and Trade Committee today. The Governor is hopeful that the banks’ sense of “social responsibility” will do its part to ease the rising debt burden of the public, RÚV reports.

Continued inflation a disappointment

As noted by RÚV, the Governor and Deputy Governor of the Central Bank answered questions at an open meeting of Parliament’s Economic Affairs and Trade Committee earlier today.

In the meeting, the Governor of the Central Bank, Ásgeir Jónsson, revealed that he had spoken with the managers of the commercial banks about responding to the increased debt burden of mortage payers. Ásgeir stated that he “could not tell the banks what to do” but that he had faith in their sense of “social responsibility,” adding that the banks needed to stand by their customers through thick and thin.

“Inflation has reached 9.9%, which is disappointing. It particularly disappoints me that the price of real estate continues to contribute to inflation,” Ásgeir also observed, observing that economic growth last year had exceeded 6%, which was “huge.”

Rising debt burden among property owners

At the meeting, Ásthildur Lóa Þórsdóttir, Member of Parliament for the People’s Party, expressed concerns about the ever-increasing debt burden of property owners due to high interest rates. Ásgeir responded that he accepted those concerns and informed Ásthildur that a conversation had taken place between the Central Bank and the managers of Iceland’s commercial banks in this regard.

“I can definitely inform you that there has been a conversation with the banks that they will be ready to respond,” Ásgeir remarked, adding that this conversation had taken place in light of the fact that “the situation could change quickly.”

Ásgeir mentioned that the banks had various devices and tools in order to accommodate the public due to the ever-increasing instalments of real estate loans – but that he also placed a certain amount of faith in the banks’ sense of social responsibility.

“I believe that they will stand by their customers through thick and thin; I think this has to be the case,” Ásgeir concluded, hopeful that the banks would accommodate their customers.

Central Bank Raises Capital Buffers to Enhance Resilience

Central Bank

Iceland’s Central Bank published its semi-annual Financial Stability report today. As noted in the report, the Financial Stability Committee has decided to increase the countercyclical capital buffer rate from 2% to 2.5%, a record high. The report also notes that although the financial system is “on solid footing,” the finances of households and companies continue to deteriorate due to persistent inflation.

The Financial Stability Committee

This morning, the Central Bank’s Financial Stability Committee (FSN) released its semi-annual Financial Stability report. The report presents an overview of the position of the financial system, its strengths and potential weaknesses, and the macroeconomic and operational risks it may face.

The report notes that the “systemically important banks” – whose capital and liquidity positions are strong – have delivered solid results and managed to provide support to households and businesses, the latter of which have struggled:

“Households’ and businesses’ financial conditions are tightening because of high inflation and interest rates. The outlook is for inflation to be stubbornly high and debt service burdens to grow heavier,” the report reads.

FSN also notes that the struggle of financial companies in international markets should serve as a reminder of the need for depository institutions to maintain sufficient strength so as to fulfil their roles, and that – given that domestic demand was strong and that developments in the financial markets were uncertain – it was “important to preserve the resilience of domestic financial institutions.”

Enter the countercyclical capital buffer.

Countercyclical capital buffer

As noted in an article in Vísir, during the restructuring of the banking system after its collapse in 2008, the defences of the financial system were strengthened and various safeguards were put in place. Among other things, a so-called countercyclical capital buffer was introduced, which is a requirement that the banks accumulate capital to create buffers to enhance the resilience of the banking sector during periods of stress. It was abolished in the fall of 2020 but reinstated last year (at 2%).

As noted in the Financial Stability report, the FSN has decided to increase the countercyclical capital buffer rate from 2% to 2.5%, a record high. (The Committee’s decision will take effect twelve months from now.)

Vísir quoted Governor of the Central Bank Ásgeir Jónsson as saying that this increase should serve to, on the one hand, “slow down the banking system’s lending,” and, on the other, be of benefit in case there is “a hard landing in the economy in a year or two.” “So with these measures, we are actually trying to slow down the financial system,” Ásgeir observed.

As noted by Vísir, Ásgeir was unwilling to comment on the likelihood of the Central Bank further raising the interest rate (the decision will be announced on Wednesday next week); most forecasters expect the interest rate to rise by up to 0.75%. It would be the Central Bank’s twelfth interest rate increase in a row.

National Pact Required to Fight Ongoing Inflation

The Governor of the Central Bank has stated that a national pact may be needed in order to overcome persistent inflation, RÚV reports. Whether or not the country is able to leave indexed loans behind, depends, to some extent, on the nation itself. The Finance Minister agrees with these ideas.

Depends on the nation to some extent

As noted by RÚV, the Governor of the Central Bank, Ásgeir Jónsson, was quoted in an article in Markaðurinn, on June 17, 2020, as saying that “an increase in the issuance of non-indexed loans would be a major turning point and would mean that indexation would die out.” He believes that it depends, to some extent, on the nation itself whether or not indexed loans would become a thing of the past:

“I had envisioned that we could have a nominal interest loan system, which I believe has many advantages over indexed loans. Based on both lower macroeconomic and a more active monetary policy. But it’s quite obvious that if we don’t succeed in keeping inflation down, it’s difficult to adopt such a system,” Ásgeir told RÚV yesterday.

Ásgeir stated that it was possible to change the terms of non-indexed loans to accommodate borrowers when instalments rise. He believes that a new national pact may be needed to overcome persistent inflation. When asked what such a consensus would entail and who would participate, Ásgeir responded thusly:

“A National pact is, naturally, based on parties within the labour market, as was the case when the first national pact was struck around 1990, regarding realistic targets for purchasing power, and so on. Such a pact is also predicated on a certain level of trust between the parties – and government involvement.”

Minister of Finance agrees

The Minister of Finance, Bjarni Benediktsson, told RÚV yesterday that he agreed with the Governor of the Central Bank regarding this national pact against inflation, stating that such efforts had long been discussed within parliament.

After the economic crisis in 2008, economic stability was tackled by the government. A consultation forum was established with the aim of increasing prosperity, where it became clear that various reforms were necessary; the Central Bank had been afforded better management tools, public finances were cleaned up, and actions were taken to strengthen the framework for economic stability.

“There is no question that the stakes are high, regarding, for example, the next round of wage negotiations and our plan to improve the state finances over the coming years. It is of great importance, first of all, for households; second, for the economy as a whole, and this matters, also, in regard to the state treasury and the local authorities, too. It’s simply really important to keep inflation down; interest rates will follow suit and capital costs will decrease,” Bjarni Benediktsson told RÚV.

Bjarni added that inflation expectations were out of control and that the market had “lost faith that inflation could be contained.” The Central Bank’s primary role was to bring inflation down to 2.5%, however, Bjarni noted, it could not tackle the issue alone. The labour market played a big role, given, especially, that there was currently no wage agreement with government employees and that it would not be long before contracts on the public market would expire again. Bjarni also noted that the excessive salaries of CEOs would need to be addressed.

“I completely agree [that CEO salaries need to be curbed]. In terms of taxation, we have a special tax bracket for such income and there is no doubt that we do not want to see wage increases in the upper brackets given the circumstances. Such increases are absolutely the worst solution in a situation where we are trying to create harmony and convince everyone to pitch in.”

Rising Interest Rates Complicate Upcoming Wage Negotiations

central bank iceland

The recent hike in interest rates has complicated the upcoming wage negotiations, with government involvement now a possibility to bring the negotiations to a conclusion.

Now, Prime Minister Katrín Jakobsdóttir has invited leaders from both sides of the bargaining table to a meeting to find a path forward.

This fall, around 1/3 of labour contracts are expiring and need to be renegotiated. Matters have been further complicated by turmoil at the 45th ASÍ congress (The Icelandic Federation of Labour, Iceland’s largest federation of trade unions), which have left the leadership of this organisation unclear. Individual unions have begun renegotiating their contracts, mostly with SA (The Confederation of Icelandic Employers).

Read more: Interest Rates Continue to Increase

Recent increases to the interest rate in Iceland have complicated negotiations, with talks with VR and several other unions and SA breaking down yesterday. The rate increases came in the wake of inflation numbers for October being higher than expected. The 0.25% increase to 6% interest (seven-day term deposit rate) is intended to bring inflation back into an acceptable range. Ásgeir Jónsson, Governor of the Central Bank of Iceland, has previously called on the labour market to help in the fight against inflation, as wage demands at the bargaining table could have an exacerbating effect on inflation.

Alongside the rate increases, the Central Bank of Iceland’s Monetary Policy Committee released a statement that inflation forecasts could turn out to be too optimistic if the ongoing wage negotiations lead to wages rising in excess of the Central Bank’s predictions. Consumer spending in September and October has proved higher than expected, and some fear that wage demands may drive up consumer spending and therefore prices.

Vísir quotes Ásgeir as stating “Our task is to ensure price stability and we believe by doing this, we are supporting the wage negotiations. It would be futile to negotiate such wage increases only to have them burn up in inflation. The Central Bank is therefore of the opinion that it is contributing to the process by ensuring this does not happen.”

Finance Minister Bjarni Benediktsson stated regarding the rate hikes that although the increase had been a “splash of cold water” for many, it nevertheless sent “a necessary message to leaders in the labour market.”

The Central Bank of Iceland’s Monetary Policy Committee has a set inflation target of 2.5%. Inflation currently sits at 9.4%.

iceland interest rate
Interest Rates – From Central Bank of Iceland

The rate hike has, however, drawn critique from both sides of the bargaining table.

Ragnar Þór Ingólfsson, the chairperson of VR trade union, said that because of this, the negotiations between VR and SA will be terminated and, as a result, harsh measures will have to be taken. Halldór Benjamín Þorbergsson, director of SA, also said he disagreed with the Central Bank’s interest rate decision. The decision, according to Halldór, put the wage negotiations in “upheaval” and the bank’s credibility has been “damaged” by this interest rate increase.

Prime Minister Katrín Jakobsdóttir has stated that the government supports a quick conclusion to the negotiations, suggesting the possibility of shorter-term contracts as a solution: “I think that all parties understand that events have not been particularly favourable for us. First an epidemic, then a war, inflation and the consequences of Russia’s war in Ukraine. So, of course, we all realize that there is considerable uncertainty, which may make a short-term contract a more viable option. But it is of course entirely in the hands of those sitting at the negotiating table to make that decision.”

Katrín continued, saying that it would be bad for all parties involved if negotiations were to break down: “Of course that would be bad. It is in the interest of all in our society that there is peace in the labour market. That workers can live on their wages. That business can continue. It’s in all of our interests.”

 

Latest from Central Bank: Interest Rates to Increase 0.25%, Now Resting at 6%

inflation rate iceland

The Monetary Policy Committee of the Central Bank of Iceland has announced today that key interest rates will be raised an additional 0.25%, with short-term interest rates (seven day term deposits), now sitting at 6%.

Read more: Key Interest Rates Increased 0.25%

The increase in interest rate comes in response to October inflation, which rose slightly to 9.4% from September’s level of 9.3%. Previous raises to the interest rate were introduced in order to cool the market and fight inflation, but have not had the entire effect hoped for.

Interest rates in Iceland now rest at:

  • Overnight loans 7.75%
  • Seven-day collateralised loans 6.75%
  • Seven-day term deposits 6.00%
  • Current accounts 5.75%

With the Central Bank’s aim of stabilising prices, it has noted that price increases continue to be widespread, but that they hope to reduce inflation to 4.5% by the end of 2023.

Read more: September Inflation Rate Drops

In the Central Bank report, it is stated that the Icelandic króna has seen a depreciation since October, and that inflation rates in the bond market have also risen since last month.

With the new measures in place, the Central Bank reports an improved economic outlook for 2023, with an expected 2.8% growth in GDP, up from its previous estimate of 1.9%.  This growth is accounted for by higher levels of domestic demand than previously forecast.

The Central Bank has also stressed the importance of developments in the labour market in bringing inflation back to acceptable levels, a reference to the previously postponed and now upcoming wage negotiations between many of Iceland’s largest trade unions and SA, the Confederation of Icelandic Employers.

 

Central Bank Raises Key Interest Rate by 0.75%

Central Bank

The Central Bank of Iceland has raised interest rates by 0.75 percentage points. The hike takes the Bank’s key interest rate to 2.75%.

Decade-high inflation rates

In the shadow of rising inflation, the Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to raise the Bank’s interest rates by 0.75 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will, therefore, be 2.75%.

The inflation rate in January was 5.7% – the highest since April of 2012 – and the Central Bank predicts an inflation rate of +5% in 2022 (+5.8% in the first quarter), which is double the Bank’s target.

As noted in an announcement this morning, the MPC will not only raise key interest rates but also employ all of its available instruments to ensure that inflation rates subside to target levels within an acceptable timeframe.

More jobs, less unemployment – but “considerable uncertainty”

The increase in interest rates coincides with the publication of the latest edition of the Monetary Bulletin (Peningamál). (The Monetary Bulletin, published on a quarterly basis, contains an “inflation and macroeconomic forecast along with comprehensive analysis of economic and monetary developments and prospects.”)

As noted in the Bulletin, GDP growth exceeded November forecasts by 1%; GDP growth in 2021 was 4.9%, and the Central Bank predicts similar growth in 2022.

“Jobs have continued to grow, unemployment has decreased, and the production slack that formed in the wake of the COVID-19 pandemic is expected to disappear. There is, however, considerable uncertainty.”

The MPC states that inflation outlooks have worsened considerably since the committee’s last meeting. The headline inflation rate has risen to an estimated 4%. Furthermore, inflationary expectations have increased according to several indicators, with the rise in housing prices having a considerable effect, in addition to increases in several items of domestic expenditure.

Non-indexed mortgages a worry

As reported by Kjarninn yesterday, Drífa Snædal, President of the Icelandic Confederation of Labour, wrote a letter to the MPC yesterday asking it to refrain from raising interest rates.

In her letter, Drífa stated that “sharp increases in interest rates have already put many households in a difficult spot. Many households have committed to non-indexed mortgages, owing both to favourable conditions and to indirect encouragement on behalf of the government and the Central Bank.”

The Central Bank will hold a live broadcast at 9.30 AM.

Muddying the Waters—the Debate Over Special Interest in Iceland

Central Bank

“By and large controlled by special interest.” In a recent interview with Stundin, Ásgeir Jónsson, Governor of Iceland’s Central Bank, stated that Iceland was “by and large, controlled by special interest” and that “quarrelling with them was no laughing matter.” Ásgeir’s comments were in part inspired by an ongoing dispute between the Central Bank and […]

This content is only visible under subscription. Subscribe here or log in.

Continue reading