In the policy statement accompanying today's decision, the MPC stated that, if the króna holds steady or appreciates, and if inflation subsides in line with forecasts, preconditions for further monetary policy easing should remain in place. The scope for interest rate cuts will be limited, however, as long as Iceland's access to global financial markets remains uncertain.

The króna is likely to remain stable until the MPC's next decision date, 17 March, if the capital controls continue to hold. Furthermore, it can be assumed that inflation excluding indirect tax effects will subside until that time, even though headline inflation may rise as a result of tax hikes. Consequently, these two preconditions for further rate cuts will probably still be in place on the next MPC decision date; however, there is great uncertainty about potential changes in access to foreign credit, and as the MPC points out, this could limit the CBI's scope for further monetary easing. Thus it appears that one of the major uncertainties surrounding the next stage in the easing cycle is the outcome of the deposit guarantee dispute about the Landsbanki Icesave accounts.

Trading in T-notes has been quite brisk this morning, while indexed bonds have seen less activity. T-note trading totalled ISK 9.7 bn as of this writing (2 p.m.), while indexed bond volumes were only ISK 2.0 bn. Most Treasury note yields have fallen by 5-15 bp so far today, although some selling interest emerged as the day wore on . HFF bond yields have risen marginally, furhter adding to yesterday's steep increase.

Lower inflation in 2010
The CBI now assumes that inflation will be rather lower this year than previously projected and has revised its average 2010 figures downward accordingly, from 6.1% to 5.6%. The CBI forecast states that the newly passed National Budget for the current year will affect inflation in the near term. However, the updated forecast assumes a smaller increase in indirect taxes and a less marked overall impact on price levels than according to the November forecast. Inflation will therefore be somewhat lower than previously forecast in the first half of 2010 but will be higher in 2011 because of adverse developments in underlying inflation, owing to a weaker króna, higher wage costs, and increased inflation expectations. The forecast projects that inflation will measure 4.3% in 2011 and about 2.2% in 2012.

Unemployment forecast broadly unchanged
The CBI's updated unemployment forecast largely accords with the prior forecast, with projections now about 9.5% instead of the previous 9.8%. The CBI projects that unemployment will rise as the year passes, peaking in mid-year at around 10%, and remaining in the 9%-10% range well into Q2/2011. The bank expects unemployment to abate gradually thereafter, as economic activity gains momentum. The CBI's projects unemployment at about 9% in 2011 and 6.8% in 2012.

Deeper contraction
The Central Bank now projects that the contraction for 2010 will be deeper than in the November forecast, with GDP shrinking by 3.4% this year instead of the previously estimated 2.4%. According to the updated forecast, recovery will be delayed by one quarter in comparison with the November projections. The larger contraction is due mainly to a more negative contribution from external trade, as the forecast of a roughly 3% contraction in domestic demand is virtually unchanged from the last forecast. In 2011, however, more robust growth in domestic demand will result in 0.4% more GDP growth than was allowed for in the November forecast, while the more negative contribution from external trade in 2012 partly explains the lower GDP growth forecast for that year.