Over the year, i.e. from the beginning of January 2003 to the corresponding period in 2004, inflation measured 2.4%. This is just below the target. Excluding changes in the price of public services, the rate of inflation was somewhat lower. Until the closing months of 2003, goods prices were somewhat lower than the previous year, and the increase in prices of services slowed down significantly. Substantial increases were seen in housing prices, however, and the housing component of the consumer price index rose by much more than the CPI as a whole. Housing inflation began to inch downwards in the course of the year and this development has continued so far this year. The Central Bank can thus feel satisfied with the rate of inflation in the recent term, and bearing in mind the long lag in the transmission mechanism, price developments indicate that monetary policy over the preceding period has had the intended effect. The Central Bank lowered its policy interest rate to 5.3% in the beginning of February 2003. Its inflation forecasts did not warrant any further changes in the policy rate by the Bank. The policy rate was broadly neutral during the year, i.e. it neither stimulated nor dampened demand. In real terms the policy rate was therefore not far from the estimated equilibrium real interest rate during the year. Output growth Iceland experienced robust output growth from 1996 until 2002, when it was marginally negative. Output growth recovered last year.
Because it is more economical for business transactions and liabilities to be denominated as far as possible in the same currency, a fundamental change in the position of the króna is unlikely, except directly by an act of government, or indirectly in the highly improbable event that economic policies were to collapse and erode all confidence in the króna, with accompanying hyperinflation, as has happened in some Latin American countries that have adopted the dollar or others that have been forced to adopt another currency. It has sometimes been claimed that the heavy level of external debt means that interest rate decisions by the European Central Bank possibly have even more impact in Iceland than domestic monetary policy. There is nothing new about the impact of foreign interest rate developments being felt in Iceland - and the same applies to other countries as well - although the scale of Iceland’s foreign debt leaves its economy more susceptible to foreign interest rate movements. It is worth remembering that while foreign interest rate developments mostly affect Iceland’s national income, economic cycle and current account balance, they can never have a crucial impact on the domestic rate of inflation. A heavy weight of foreign currency-denominated borrowing in domestic debt may complicate the transmission mechanism of monetary policy. In the long run, however, only domestic monetary policy measures can determine a deteriorating value of the domestic currency vis-à-vis goods and services or to put it plainly, inflation. Prospects Finally, I shall turn to economic and monetary prospects.