Iceland Cuts Benchmark Rate to 4.5% as Inflation Declines to Six-Year Low
Iceland Cuts Main Rate to 4.5%
Arnaldur Halldorsson/Bloomberg
The logo of the central bank of Iceland is displayed at their headquarters in Reykjavik.
The logo of the central bank of Iceland is displayed at their headquarters in Reykjavik. Photographer: Arnaldur Halldorsson/Bloomberg
Iceland’s central bank cut its main interest rate by 1 percentage point as the western nation hardest hit by the global financial crisis emerges from its 2008 banking failure, allowing the $12 billion economy to stabilize.
Sedlabanki lowered the seven-day collateral lending rate to 4.5 percent, the Reykjavik-based bank said on its website today. The bank also cut the deposit rate to 3.5 percent from 4 percent. Policy makers have reduced the benchmark 14 times from a record 18 percent since obtaining a $4.6 billion loan from a group led by the International Monetary Fund at the end of 2008.
A stable krona may allow policy makers to keep cutting interest rates, the bank said today. “The appreciation of the króna, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation,” the bank said.
Capital controls have protected the krona from a sell-off and allowed the island’s trade surplus to support the exchange rate. The currency has gained 21 percent against the euro over the past year, while the annual inflation rate fell 0.7 point to 2.6 percent last month, the lowest in six years. The central bank, which has led the world in rate cuts this year, says it won’t start easing capital controls until March 2011 at the earliest.
The krona gained 0.1 percent to 151.80 at 11:20 a.m. in Reykjavik. The currency has appreciated 3 percent against the euro since an Oct. 22 low.
‘Considerable’ Cut
“Most of the conditions are in place for a considerable interest rate cut” because “everything indicates that the government intends to remove the capital controls slowly next year,” said Ingolfur Bender, head of research at Islandsbanki hf, in a note before the rate announcement.
The economy grew last quarter for the first time in two years as exports support its recovery. Gross domestic product expanded 1.2 percent in the third quarter from the second, the statistics office said yesterday.
“The economy is expected to hit bottom in the next few months,” Bender said. “The pre-conditions for growth have been re-established after a massive correction.”
The failure of Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf more than two years ago precipitated an 80 percent decline in the krona against the euro offshore. Iceland resorted to capital controls to protect the economy after allowing its banks to fail.
Ireland Contrast
Iceland’s policies for dealing with its crisis are in contrast to those chosen by euro members Greece and Ireland, also relying on IMF-led bailouts to stay afloat. Ireland last month agreed an 85 billion euro ($112 billion) international loan to help rescue its banks, forcing taxpayers to foot the bill of supporting the lenders.
According to President Olafur R. Grimsson, the decision to let Iceland’s banks fail is helping the economy to rebound.
“The state did not shoulder the responsibility of the failed private banks,” he said in a Nov. 26 interview with Bloomberg Television’s Mark Barton. Deciding who should bear the cost of banking failure is becoming a “burning” question in Europe, Grimsson said.
Creditors in Iceland’s failed banks are still trying to recoup $85 billion. Kaupthing bondholders can expect to get 26 cents per euro back on their investment, according to brokerage H.F. Verdbref hf.
In Limbo
The island’s capital controls have left foreigners holding krona-denominated assets in limbo. The central bank estimates foreigners are locked into about $3.6 billion -- mostly in the form of krona-denominated bonds issued outside the island --that can’t be exchanged until the capital controls are lifted. The Eurobonds, known as Glacier bonds, will probably be the last to be freed from currency restrictions, Governor Mar Gudmundsson said in September. Bonds with the longest maturities will be exempt first, Deputy Governor Arnor Sighvatsson said.
The economy will return to growth in 2011, the central bank estimates, as the island emerges from its longest period of economic decline since gaining independence from Denmark in 1944.
The IMF finished its third review of Iceland’s economic program in September, freeing a $167.5 million payment. The fund’s fourth review is scheduled for December, Prime Minister Johanna Sigurdardottir said in November.
To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik valdimarsson@bloomberg.net.
To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net.
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