Iceland's central bank left interest rates unchanged on Wednesday citing modest growth prospects and higher inflation outlook owing to a weaker krona.
The Monetary Policy Committee of the Sedlabanki held the key policy rate, which is the seven-day collateralized lending rate, at 6 percent for the second straight session.
The decision was in line with expectations. The rate was last hiked by 25 basis points in November and left unchanged in December.
"The accommodative monetary stance has supported the economic recovery in the recent term," the bank said. "As spare capacity disappears from the economy, it is necessary that monetary policy slack should disappear as well."
The degree to which such normalization takes place will depend on future inflation developments that is subject to exchange rate movements and wage-setting decisions in the near future, the bank pointed out.
Output growth in 2012 was weaker than previous anticipated, the central bank said. The bank expects more modest growth for this year than was forecast in November.
While modest growth will ease inflationary pressures somewhat, near-term inflation is projected to be higher than was forecast in November, owing to a weaker krona, the bank said. The inflation outlook for the forecast horizon as a whole is therefore broadly unchanged since then, it added.
The bank blamed poorer terms of trade for a reduction in trade surplus at a time of extensive currency accumulation for foreign loan payments. This led to a depreciation of krona.
"There is considerable uncertainty about the persistence of these effects and therefore about near-term exchange rate developments," the Sedlabanki said. "There is also the risk that self-fulfilling expectations of a depreciation will weaken the krona still further."
Citing such conditions, the bank announced a halt to its programme of regular foreign currency purchases. The bank plans to support the króna through foreign exchange intervention.
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