Central Bank of Iceland - Annual Report 2006

"Indications of imbalances included production far in excess of estimated capacity, labour shortages, a record current account deficit and inflation far above target.

"The main task of monetary policy during the year was therefore to tackle inflation, the result of imbalances that were driven by investments in the power and aluminium sectors and changes in the financial sector in recent years. In March, estimates for domestic demand, and particularly investment, in 2004 and 2005 were revised sharply upwards. In 2006 domestic demand growth also appears to have outstripped earlier forecasts. The krona depreciated rapidly in the spring as well. Thus the inflation outlook took a marked turn for the worse in the first half of the year. In response, the Central Bank raised its policy interest rate seven times in 2006, by a total of 3.75 percentage points to 14.25% by the end of the year. Since the Central Bank embarked on the current cycle of hikes in May 2004, the policy rate has been raised by 8.95 percentage points.

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