Iceland Ramps Up Tightening in Biggest Rate Hike Since 2008

(Bloomberg) --

Iceland's central bank delivered its biggest interest-rate hike since the 2008 financial crisis to try to curb inflation and rein in Europe's fastest house-price rally. 

The Monetary Policy Committee in Reykjavik lifted the seven-day term deposit rate by 100 basis points to 3.75%, accelerating tightening with its largest move yet since the pandemic. Officials markedly raised their inflation forecast, anticipating annual price increases exceeding 8% in the third quarter. 

“The MPC considers it likely that the monetary stance will have to be tightened even further in coming months,” the central bank said in a statement. “Decisions taken at the corporate level, the labour market, and in public-sector finances will be a major determinant of how high interest rates must rise.” 

The hike keeps Iceland in the vanguard of global tightening on a day when the U.S. Federal Reserve is anticipated by economists to accelerate its own shift with a half-point increase, responding to inflation stoked by fallout from the war in Ukraine.

Elsewhere, the Bank of England is expected to raise rates on Thursday by a quarter point to 1%. On Tuesday, Australia's central bank also began hiking with a quarter-point move enacted in the middle of an election campaign.  

Icelandic policy makers accompanied their increase with a warning that prices risk accelerating even further if pay demands aren't kept in check.  

“Given the recent rise in long-term inflation expectations, there is greater risk that the inflation outlook as depicted in the bank's forecast is overly optimistic,” they said. “The risk of a wage-price spiral would grow if next winter's wage settlements provide for large pay hikes.” 

Standing Out

Iceland's central bank was the first in western Europe to tighten since the pandemic struck, and has stayed hawkish since then as it struggles to tame consumer-price growth, now at the highest level since 2010. 

Even so, the North Atlantic nation no longer stands out globally in the way that it did when it started raising rates last year, Governor Asgeir Jonsson said in March. 

While Iceland's economic outlook has deteriorated since the invasion of Ukraine, rising inflation pressures from higher global commodity prices have complicated officials' task of quelling a housing rally that's spurred inflation, which includes real-estate costs. Consumer-price growth accelerated to 7.2% in April, well above their target of 2.5%.

Housing values in the area of the capital surged 19.1% on the year in April amid a shortage of new homes. Between 2010 and the end of 2021 they grew by 150%, the most in Europe, according to Eurostat.

“House prices and other domestic cost items are strong drivers of inflation, and global oil and commodity prices have risen sharply,” the central bank said. “It is assumed that the combination of interest-rate hikes and tighter borrower-based measures will slow down house-price inflation and domestic demand.”

While officials reckon the real-estate market may cool in the second half of the year, a sudden increase in immigration could renew pressure on prices by stoking rental demand, they said. 

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