In part the policy stance of the European Central Bank has to the extent possible been guided by efforts to drive growth with low interest rates, while the Central Bank of Iceland’s objective has by and large been to contain economic overheating. The current account deficit and the labour market Iceland’s external balance has been volatile in recent years. A current account deficit equivalent to 10% of GDP in 2000 was virtually eliminated within two years, but widened sharply again in 2003. After reasonable balance in the first quarter and a sizeable merchandise account surplus, the deficit in the second and third quarters was the largest since the beginning of 2001. For the year as a whole, the current account deficit was equivalent to 5½% of GDP. A recession in exports was a strong contributing factor, along with rising imports driven by private consumption, but much of the widening current account deficit may be ascribed to imports of investment goods for a hydropower project. In this respect the deficit is benign in origin, although the pace of increase so early on in the upswing is a cause of some concern. As is commonly the case at the onset of a growth episode, the increase in demand for labour was fairly slow during the year. The unemployment rate came down more slowly than had widely been expected given the surge in vacancies registered with employment agencies. Seasonally adjusted unemployment began to decline slowly from the autumn onwards.
The Central Bank does not consider that there are grounds for raising the policy rate yet, but all things being equal the inflation forecast calls for a higher policy rate in the coming months, even though the inflation outlook is favourable until some time next year. Because monetary policy needs to be forward-looking, this could well mean that the Central Bank will raise its interest rate even though inflation is still below the target. Largescale investments over the next few years mean that monetary decisions need to take into account a longer horizon than usual. Considerations of financial stability call for the same approach. Ladies and Gentlemen: Inflation forecasts play a key role in the Central Bank’s monetary policy decisions. Looking into the future is always difficult, but I think that the Central Bank can feel satisfied with how accurate its inflation forecasts have turned out to be. I would like to conclude by thanking the Office of the Prime Minister and other government authorities for their pleasant cooperation. I also thank the financial institutions for their good collaboration. Last but not least, I would like to thank the employees of the Central Bank for their fine work, without which the Bank could not have achieved such impressive results. 6  BIS Review 18/2004