Be that as it may, the economy was no less overheated than forecast in mid-2006, as witnessed by the current account deficit and tight labour market. Thus it is untenable to claim that the Central Bank’s policy rate hikes in 2006 were unwarranted. On the contrary, a higher policy rate was the main precondition for the króna to hold relatively strong, and contributed to subduing demand growth. Had the Central Bank not raised its policy rate, there is little doubt that inflation would be higher than at present. Some commentators who were surprised by the December policy rate hike apparently considered that the Central Bank had underestimated the scope of the turnaround in the economy in the second half of the year. National accounts statistics for Q3 that were published in mid- December, supposedly showing a substantial slowdown in economic activity, were repeatedly cited as evidence. The Central Bank considers it imprudent to draw sweeping conclusions solely from preliminary estimates in the quarterly national accounts, which tend to undergo sharp revisions. For this and other reasons, a  BIS Review 16/2007  3  broader range of indicators contributed to the December policy rate decision, including the current account deficit and labour market conditions. The scenario today is that commercial bank analysts expect the cycle of policy rate cuts to begin later this year than they were forecasting towards the end of 2006. In other words, they consider that more underlying pressures remain in the economy than they may have thought at the time.
As I mentioned earlier, the Central Bank left its policy rate unchanged on the last interest rate decision date, February 8. In December it raised the rate to 14.25%. This was the eighteenth hike since May 2004; prior to that, the policy rate had been held at 5.3% for more than a year. The Central Bank noted that its December hike seemed to come as a surprise. The introduction to Monetary Bulletin, which was published on November 2, stated that a reduction in the policy interest rate was still not in sight, in spite of substantially brighter inflation prospects. On the contrary, it was impossible to rule out a further policy rate hike in order to attain the inflation target within an acceptable timeframe, and the analysis presented then implied that there were still grounds for tightening the monetary stance further. However, the Board of Governors had decided to postpone such a measure for the time being. The next interest rate decision, to be announced on December 21, 2006, would be based on the analysis in the November Monetary Bulletin and additional data that became available by that time. The Chairman of the Board of Governors underlined this message from Monetary Bulletin in a speech a few days later when he described the decision to leave the policy rate unchanged on November 2 as a deferral of an increase rather than the end of the tightening of the stance.