Central Bank of Iceland cuts key rate by 25bp to 7.25% and forecasts inflation back at target in early 2027

The Central Bank of Iceland’s Monetary Policy Committee cut policy rates by 0.25 percentage points, taking the key interest rate on seven-day term deposits to 7.25%. The accompanying Monetary Bulletin update points to weaker near-term domestic activity, an easing labour market and a faster projected return of inflation to target. Iceland’s GDP growth in H1 was 0.3% year on year, below the August Monetary Bulletin forecast, and revised data suggest GDP contracted by 1% in 2024; GDP is also estimated to have shrunk in Q3 2025. Growth for 2025 is projected at 0.9% (down from 2.3% previously) and 2026 growth at 1.6%, with the downgrade linked largely to recent shocks to export sectors, while growth later in the horizon is expected to average 2.5%. Labour market tightness has eased, with unemployment projected to average 4.5% in 2026 before tapering off in H2; the central bank now expects slack to open up in H2 2025 and persist for most of the forecast horizon. Inflation measured 4.3% in October and underlying inflation has edged up, with inflation expectations still above target. Even so, the near-term inflation outlook is described as improved and inflation is projected to fall to 3.5% around mid-2026 and align with the target in early 2027, reflecting a more favourable starting point and more slack in the economy, partly offset by a weaker exchange rate; the bulletin also highlights uncertainty around the effects of US tariffs, domestic export shocks and mortgage market turbulence on inflation and demand.