High Interest Rates Don’t Build Homes
14. August 2025A Central Bank at a Dead End
Next week, the Central Bank will announce its decision on interest rates. Analysts are stepping forward one after another, claiming that a reduction in interest rates is impossible, but more and more voices are also pointing out what VR has been saying for a long time: the high-interest policy causes immeasurable harm and needs to come to an end.
Inflation originally took off due to mismanagement in housing affairs and domestic price increases on the one hand, and due to the war in Ukraine and supply chain disruptions during the COVID pandemic on the other. The Central Bank began its interest rate hike cycle four years ago after a short period of low rates. In April 2023, they had reached 7.5% and then rose sharply, holding at 9.25% for a full year. The low-interest period (2.5% and below) lasted shorter than the high-interest period, which has now lasted almost three years.
A Homegrown Problem
During this high-interest period, working people have borne immeasurable burdens while agreeing to modest pay rises in collective agreements. The housing crisis has worsened, and we are now seeing a significant decrease in the number of residential units under construction while the public’s distress is increasing. The causes are multifaceted, but a key factor is the high cost of capital due to interest rates, which makes it difficult for developers to build and for people to buy. High interest rates and strict lending conditions exclude large groups of young people and renters from securing a safe roof over their heads. This in turn directly affects the entire housing market, as is clearly seen in the pressures on the rental market and the broken chains of real estate purchases.
Today’s inflation is not coming from abroad but is largely a homegrown problem. High interest rates don’t build homes; they actually hinder housing development and contribute to sustained inflationary pressure. High interest rates also don’t stop the profit-seeking of companies that increase their profits year over year during times when they should have shown restraint. They haven’t stopped candy manufacturers from raising prices on jelly candies citing global cocoa prices (!), they haven’t ensured that currency strengthening benefits consumers in Iceland, and high interest rates don’t stop meat price hikes brought on by consolidated producers. At the same time, there is little sign of government action in housing matters, and municipalities have not fulfilled promises made in relation to collective agreements.
We are now living through one of the longest continuous inflation periods in recent years. Although inflation has dropped since the signing of collective agreements in March 2024, it takes very little for it to rise above the 4.95% benchmark stated in the terms of the agreements. This benchmark was high, and working people with housing debt or in the rental market have had to shoulder enormous burdens from both rising prices and increased interest costs. But not everyone loses from inflation and high interest rates. Large companies are increasing their profits, capital owners are making a killing, and banks are enjoying a boom, raking in money directly from the public’s pockets.
The upward redistribution of capital continues.
A Central Bank at a Dead End
It is generally not considered wise to do the same thing over and over and expect a different outcome. The Central Bank seems to be stuck in a dead end of its own making. VR has repeatedly pointed out that the aggressive use of the interest rate tool not only hits the wrong targets, it also does not serve the purpose of lowering inflation. It is now vital that the Central Bank think outside the box and face the systemic drivers of inflation in the Icelandic economy — the housing market along with profit-driven price hikes. Otherwise, the continuation of the high-interest policy will increase inflation in the long term by preventing essential housing development.
We cannot treat people’s housing as a playground for investors, where the fundamental right to a secure home is subject to fluctuations in the financial market. The opportunity cost continues to grow, manifesting as poverty, increasing class division, and growing inequality between generations. That is why we at VR hope the Central Bank has used the summer to rethink its approach, and that the government will finally show its hand in housing matters. Interest rates must come down, the government needs to take action, and municipalities must increase the supply of buildable lots.
The time for action has long since come.
Halla Gunnarsdóttir
Leader of VR
The article was first published in Morgunblaðiið on 14 August 2025