Iceland Keeps Western Europe’s Highest Rate as Krona Stable

Iceland’s central bank kept its benchmark interest rate unchanged for a sixth consecutive meeting after intervening in the currency market and predicted it will take longer to tame inflation.

The seven-day collateral lending rate was kept at 6 percent, the highest in western Europe, according to a statement on the website of the Reykjavik-based Sedlabanki.

“The central bank’s foreign exchange market strategy, introduced in May, has contributed to reduced exchange rate fluctuations, and the krona has remained relatively stable,” the bank said. “As yet, however, this development has not led to lower inflation expectations.”

Iceland suspended foreign currency purchases designed to build up reserves at the beginning of the year and in February announced it would instead buy kronur to take pressure off rates. Policy makers are seeking to protect the currency from losses as they try to phase out capital controls in place since the island’s 2008 economic meltdown.

“The central bank raised interest rates too hastily last year and the economy slowed down last winter,” said Asgeir Jonsson, an economist with Reykjavik-based asset manager Gamma. “The central bank has decided to wait with further rate hikes and I don’t see them raising rates before the new year.”

The krona slid 0.3 percent to 120.18 per dollar today as of 10:56 a.m. Reykjavik time. It was little changed at 160.85 per euro.

Target Delayed

The krona has gained 8.7 percent against the euro from a low in January, helping ease inflation to 3.8 percent in July, from more than 6 percent last year. The bank has raised rates six times since August 2011 to prevent krona losses.

The bank today said the economy will expand 1.9 percent this year, raising a May forecast for 1.8 percent growth. Gross domestic product will advance 2.8 percent next year. Inflation will average 3.8 percent this year, 3.1 percent next year, the bank said. Inflation won’t reach the 2.5 percent target until the second quarter in of 2016, versus an earlier assessment for the end of 2014, the bank said.

‘Action Plan’

Prime Minister Sigmundur Gunnlaugsson on June 10 pledged a new “action plan” to cut household debt burdens that are hampering Iceland’s economy and enact changes to the island’s capital controls. A taskforce appointed to present proposals on how to achieve the government’s goals is supposed to deliver its results in November.

Gunnlaugsson’s Progressive Party and the Independence Party ousted the Social Democrat-led coalition in April by promising tax cuts and mortgage relief.

Iceland, which completed a 33-month International Monetary Fund program in August 2011, is now outgrowing much of Europe as it recovers from its recession.

“There is some uncertainty about the path public sector finances will take in coming years, but that should diminish with the presentation of the fiscal budget proposal in early October,” the bank said today. “It is critical that Treasury finances be brought into balance as soon as possible so that the monetary and fiscal policy mix contributes to external balance of the economy, fosters overall economic stability, and delivers inflation close to target, at the lowest possible cost. ”

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