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Iceland's central bank now has more scope to cut interest rates as a result of this week's agreement between workers and employers, despite an “unfortunate” clause in the deal that ties planned pay hikes to monetary policy, Governor Mar Gudmundsson said.
“The break-even inflation rate in the market has now slumped, the exchange rate has been strengthening and our leeway to lower interest rates has greatly increased,” Gudmundsson said by phone in Reykjavik.
Iceland's trade unions and employers' representatives ended months of fraught labor talks on Wednesday with a complex agreement that also includes a series of government measures aimed at supporting the country's poorest.
One clause in particular, which makes pay increases contingent to a rate cut, has been slammed by economist and policy makers.
“Making the contracts conditional on the interest rate level in one-and-a-half-year's time, when no one knows what circumstances we will be facing then, was an unfortunate mistake,” Gudmundsson said Friday.
Read more on Iceland's “crazy” wage deal
The clause was introduced as a means of breaking the deadlock after months of wage talks that stoked uncertainty in Iceland, causing the central bank to waver. The island nation in the North Atlantic is reeling from the collapse of Wow Air and is facing a potential contraction in gross domestic product after years of fast-paced growth. The unions' initial demands for pay increases of as much as 40 percent had sent the inflationary alarm bells ringing, but policy makers are now expressing sighs of relief at the talks' more modest outcome.
The deal is “much better than some had feared,” Gudmundsson said, adding that financial stability was not at risk in the short run.
But the governor had harsh words for its interest rate clause, arguing that it risks posing unhealthy restrictions on monetary policy.
“If the monetary policy committee believes that moving rates above a certain level will cause the agreement to be canceled,”' Gudmundsson said, “then we might reach an outcome that isn't the best for everyone.”
Interest rates are like a steering wheel, he said. “You would never drive across the country and only turn the wheel 30 degrees in either direction.”
To contact the reporter on this story: Ragnhildur Sigurdardottir in Reykjavik at rsigurdardot@bloomberg.net
To contact the editors responsible for this story: Jonas Bergman at jbergman@bloomberg.net, Nick Rigillo
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