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Iceland to Increase Foreign Currency Purchases to Cap Krona

July 31 (Bloomberg) -- Iceland’s central bank is increasing purchases of foreign currency to cap gains in the krona as it works to unwind capital controls in place since the island’s banking meltdown in 2008.

The bank, which had purchased 500,000 euros ($612,650) every Tuesday since September 2010 from the market makers it deals with, will raise that amount to 1 million euros, it said in an e-mailed statement from Reykjavik late yesterday.

“Growing inflows and the appreciation of the krona have created room for maneuver to increase the purchases somewhat,” Sedlabanki said. “The bank considers it desirable that the purchases be sufficient to cover the interest payment on government debt and to increase the share of non-borrowed reserves over the medium term.”

The krona controls have protected the currency since Iceland’s biggest banks defaulted on $85 billion in 2008. The central bank was only able to halt a sell-off of the krona, which triggered an 80 percent plunge offshore, by imposing capital controls. It’s now seeking to unwind the restrictions in stages in an effort to normalize its capital markets.

The krona gained as much as 1.1 percent against the euro yesterday to its strongest level since March 2009.

Policy makers are seeking to phase out capital controls by the end of 2015. The restrictions have locked in about 1 trillion kronur ($8.2 billion) held by offshore investors, according to an estimate by Arion Banki hf.

So far the government has struggled to attract the euros it needs and a weakening krona prompted the government in March to close a loophole that had allowed overseas investors to speculate on the currency. The move pushed the onshore rate up about 10 percent against the euro.

The central bank in June raised interest rates for a fifth time since August to keep inflation in check. The bank estimates inflation, which eased to 4.6 percent this month, won’t return to its target of 2.5 percent until 2015.

To contact the reporter on this story: Omar Valdimarsson in Reykjavik at valdimarsson@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net

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