Iceland Central Bank Says Rate Rise Is Likely in Near Future

Iceland’s central bank said it will probably soon need to raise interest rates for a sixth time to cap inflation as the nation emerges from its economic meltdown.

“As spare capacity disappears from the economy, it is necessary that monetary policy slack should disappear as well,” the Reykjavik-based bank, which today kept its benchmark lending rate at 5.75 percent, said in a statement. Any tightening will depend on inflation developments, “but in the absence of changes in the outlook for inflation and the economic recovery, it is likely that further interest rate increases will be needed in the near future,” it said.

The bank has raised rates five times since August last year to cool inflation as it struggles to lift capital controls in place since the 2008 financial collapse. While suffering a slump in August, the krona has risen about 5 percent since April after the country closed a loophole in its controls. The controls are blocking as much as $8 billion in offshore krona assets from being sold, according to estimates by Arion Banki hf.

The krona slid less than 0.1 percent to 158.9 per euro.

The bank forecast in August that inflation will average 5.4 percent this year and slow to 3.4 percent next year and 3 percent in 2013, compared with its 2.5 percent target. Gross domestic product will expand 3.1 percent in 2012, 2.2 percent next year and 3.4 percent in 2014, the bank said then.

Weaker Krona

Annual inflation was 4.3 percent in September after reaching a 12-month low of 4.1 percent in August. A weaker currency pushes up the cost of imports for the north Atlantic island, which targets an inflation rate of 2.5 percent.

“Inflation has been somewhat lower than was forecast in August,” the bank said in a statement. “On the other hand, the krona is weaker than was assumed at that time, and the near-term exchange rate outlook is quite uncertain. On balance, the inflation outlook has not changed significantly since the MPC’s last meeting.”

Iceland, whose banks defaulted on $85 billion in 2008, completed a 33-month IMF program in August last year. The outlook for the country’s $13 billion economy is “good” and this year the island is likely to “broadly” repeat an economic growth rate of 2.6 percent achieved in 2011, the Washington-based lender said last month.

EU Talks

A working group consisting of members from the IMF, the European Commission, the European Central Bank and Icelandic officials is due to deliver an interim report on the options for removing the capital controls by year-end, the Finance Ministry said on Sept. 25.

Iceland started European Union accession talks in 2010 and the government has said it targets euro adoption as soon as possible after joining the bloc. A poll by newspaper Morgunbladid published Aug. 13 showed that 39 of the 63 lawmakers in parliament oppose continuing talks and may push the legislature to address the option of dropping membership preparations before elections next year.

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