(Bloomberg) -- Iceland’s central bank unexpectedly cut rates by 25 basis points, abruptly easing Western Europe’s most aggressive constriction as inflation starts to give in.
Policymakers at Sedlabanki reduced the 7-day term deposit rate to 9.0% on Wednesday after keeping it at 9.25% since August last year. The north Atlantic nation’s largest banks, Islandsbanki hf and Landsbankinn hf, had projected unchanged rates.
The move begins to chart a path out of borrowing costs at their highest since 2009 and signals Governor Asgeir Jonsson and his colleagues are satisfied with the headway they’ve made with inflation. Annual consumer-price growth eased to 5.4%, the slowest in two and a half years, in September.
High long-term inflation expectations remain a concern for the central bank, with housing prices driving inflation as volcanic activity has forced roughly 1% of the population to seek new homes.
“Our main problem is persistent inflation expectations,” Jonsson said in an interview following the rate meeting. “We have seen short term indicators concerning inflation expectations heading down very sharply — we still see long term inflation expectations being relatively high or above our target.”
The economy that’s run hot for the past few years is also already slowing. High rates have begun to hurt housing construction and household demand.
“It seems that extensive cooling is ongoing,” Jonsson said. “The only hot area now is the housing market,” he said, adding that the central bank expects housing prices to start easing off.
Reducing interest rates now “was a wise step,” Jon Bjarki Bentsson, head of Islandsbanki research, said by phone. “The rate cutting phase has started and I expect further reductions in the coming meetings, in the absence of a backlash in how inflation develops.”
The krona was initially little changed after the decision, later strengthening 0.3% to 149.5 per euro and near the strongest level in about two months reached on Monday.
--With assistance from Joel Rinneby.
(Updates with comments from the governor from fifth paragraph.)
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