Inflation continued to recede in March. It went from 4.2% to 3.8% and has now subsided to below the upper tolerance limit of the CBI inflation target, for the first time since year-end 2020. We expect inflation to recede at a much slower pace and to fluctuate around 4% over the next months. This mostly stems from the fact that, in the coming months, no foreseeable months with major price increases will drop out of the year-on-year comparison. We forecast 4.1% inflation in April, 3.8% in May and again 3.8% in June.
The Monetary Policy Committee (MPC) lowered the policy rate by 0.25 pp on 19 March, in line with expectations. The interest rate has been lowered more or less in tandem with receding inflation and now stands at 7.75%. Although inflation has been moving in the right direction, the MPC remains cautious, not least due to persistent inflation expectations, which have remained nearly unchanged despite declining inflationary pressure in recent months. The Central Bank must also remain vigilant regarding consumption levels: Card turnover has continued to increase and the same applies to household deposits. If these deposits were to be used to fund consumption once interest rates begin to fall, it could reignite inflation. We believe that the CBI will maintain high real interest rates and will not allow them to fall until inflation expectations have subsided.
The government presented its fiscal plan on the last day of March. The plan covers the period 2026-2030 and aims to further a balanced central government budget by one year, aiming to achieve a balanced budget as early as 2027. In 2027, the goal is to deliver a modest surplus of ISK 2 billion, followed by gradual improvements in the balance, with improvements averaging just under ISK 10 billion per year over the remainder of the period.
The plan also includes the introduction of a so-called “stability rule” which is set to replace the current fiscal balance rule. The stability rule stipulates that the underlying expenditures of Part A1 of the government budget may not increase by more than 2.0% in real terms per year, without considering changes in revenue generation. In other words, any increase in expenditures beyond 2.0% must be financed on the revenue side.
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