JAKARTA (dpa-AFX) - Iceland's central bank raised its key interest rate by 50 basis points and signaled a 'sizeable' increase in August as the bank sees rising risks to inflation outlook amid liberalization of capital controls and robust domestic demand.
As hinted earlier by the bank in May, the Monetary Policy Committee of the Sedlabanki on Wednesday lifted the seven-day collateralised lending rate to 5.75 percent from 5.25 percent. This was the first rate hike since November 2012.
'It seems apparent that a sizeable rate increase will be necessary in August, followed by further rate hikes in the coming term, so as to ensure price stability over the medium term,' the bank said in a statement.
The Sedlabanki now expects inflation to be higher than the May projections as wage increases negotiated recently have been significantly larger than it assumed in May.
The bank said the outlook for wage costs, the rise in inflation expectations and indicators of robust demand growth make it unavoidable to respond to the worsening inflation outlook, though it remains below target.
The economic growth of 2.9 percent in the first quarter together with strong recovery in the labor market suggest that economic activity is growing broadly in line with forecast published in May, it noted.
The conclusion of wage settlements will entail an easing of the fiscal stance. Moreover, the legislative measures announced by the government on Monday to liberalize capital account would potentially encourage demand.
The liberalization of capital account was adopted to ensure that winding-up of the estates of failed banks does not jeopardize monetary, exchange rate and financial stability.
Iceland had imposed capital control way back in 2008 in order to avoid a flight of funds from the country after the biggest three banks, namely Kaupthing, Glitnir and LBI defaulted on $85 billion debt.
As some of the recent measures will generate revenues for the government, it is important that these revenues be allocated so as not to stimulate the domestic economy, the central bank said.
'The MPC will monitor developments closely and will take appropriate countervailing measures if necessary,' it added.
Jessica Hinds, a European economist at Capital Economics said the bank is expected to raise its key rate by at least 75 basis points in August and smaller rate hikes later in the year so that the benchmark lending rate reaches 7 percent by year-end.
Copyright RTT News/dpa-AFX