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Iceland Raises Rates to Shield Krona From Market Turbulence

Iceland’s Central Bank Raises Benchmark Interest Rate
Iceland’s central bank raised its enchmark interest rate to 4.75 percent from 4.5 percent, Reykjavik-based Sedlabanki said in a statement on its website today. Photographer: Arnaldur Halldorsson/Bloomberg

Iceland’s central bank raised its interest rates for a second time in three months as policy makers try to shield the krona from market turbulence fueled by Europe’s deepening debt crisis.

The seven-day collateral lending rate was raised to 4.75 percent from 4.5 percent, Reykjavik-based Sedlabanki said today, after leaving rates unchanged last month. Policy makers in August raised rates for the first time since the failure of the country’s banks in 2008. The three economists surveyed by Bloomberg had expected no change.

After today’s increase, rates “seem broadly appropriate in light of the economic outlook,” the central bank said.

The central bank is emerging from crisis-management mode as Iceland’s economy recovers from its financial meltdown. At the same time, policy makers are trying to ease capital controls, in place since the end of 2008, without triggering a krona slump that risks fueling inflation. Iceland’s currency has slipped 3 percent against the euro this year, while inflation has hovered at about 5 percent since July. The bank targets price growth of 2.5 percent.

Iceland’s “economic recovery has continued, although the world’s economic growth has been reduced and uncertainty increased,” the central bank said. “It’s anticipated that growth will be greater this year and next than forecast in August and that inflation will be lower in coming weeks due to a stronger krona and less imported inflation.”

The krona gained 0.4 percent against the dollar to trade at 114.92 at 9:16 a.m. in Reykjavik.

Iceland Vs Eurozone

Iceland, whose banks defaulted on $85 billion in 2008, completed a 33-month International Monetary Fund program in August. The Washington-based fund expects Iceland’s economy to grow faster than the average for the euro area this year and next. It costs less to insure against an Icelandic sovereign default than it does, on average, to hedge against a credit event in Europe’s single currency bloc, debt derivatives show.

“Alongside the economic growth we forecast in the coming years, the economy will reach a better balance and slack in output will disappear,” Ingolfur Bender, an economist at Islandsbanki hf, said in a note to clients before the rate decision. “We expect the central bank’s repo rate will move towards a balance, which we believe is about 6 percent.”

Iceland’s $12 billion economy will grow 2.5 percent this year and next, the IMF said in September. The euro area, by comparison, will grow 1.6 percent this year and 1.1 percent in 2012, the fund estimates.

Iceland started European Union accession talks last year and the government has said it targets euro adoption as soon as possible after joining the EU.

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