- Decision
- Maintain
- Rate change
- 0 bps
- key interest rate
- 7.5%
The Monetary Policy Committee of the Central Bank of Iceland on 20 August 2025 left its monetary stance unchanged, holding the seven-day term deposit rate at 7.50 % as it judged that, despite headline inflation easing to 4 % in July, underlying pressures from robust activity, marked wage increases and still-elevated inflation expectations mean the real policy rate cannot yet be lowered. After cutting the key rate by a cumulative 75 bp between February and May, the Committee has now paused. The interest‐rate corridor was maintained with current accounts at 7.25 %, seven-day collateralised loans at 8.25 % and overnight loans at 9.25 %. Domestic demand has cooled and capacity pressures in housing and labour markets have diminished, yet the Bank’s new forecast sees inflation edging up again in coming months before gradually easing in early 2026 toward the 2.5 % target. The MPC reiterated that any further rate reductions will depend on inflation moving closer to target and that policy decisions will continue to reflect incoming data on economic activity, prices and expectations.
Rate evolution
From August 2025 to August 2026, the Central Bank of Iceland’s key interest rate ended 50 basis points higher at 8.00%, after an autumn pause, a short-lived cut, and then a return to tightening. The initial holds reflected cooling domestic demand and easing capacity pressures under tight policy, but activity remained fairly resilient, wage rises were sizeable, inflation expectations stayed above target, and the Central Bank said conditions for easing the real interest rate had not yet emerged. It cut by 25 basis points in November to offset tighter financial conditions from mortgage-market turmoil as the output gap closed and growth slowed, yet stressed that pay growth, above-target expectations and uncertainty meant further easing required clear evidence that inflation was returning to the 2½% target. By March and May, however, with inflation above 5%, underlying pressures and expectations rising, and oil and commodity price shocks from the Middle East conflict worsening the outlook, the Committee raised rates twice, judged the inflation outlook poorer despite weaker growth and higher unemployment, and signalled it was prepared to tighten further if inflation risks persisted.
In August, the Committee raised the policy rate by another 25 basis points after inflation measured 5.3% in July, citing high inflation and inflation expectations and the need to ensure sufficient monetary restraint. The Central Bank forecast inflation would rise further before tapering off relatively quickly in 2027, while noting that underlying inflation had stabilised and had begun to ease by some measures as economic slack grew, second-round effects appeared less pronounced than initially feared, and the market breakeven inflation rate had receded.