Iceland Avoids Rate Increase After Supporting Krona Market

Iceland’s central bank left its main interest rate unchanged for a seventh consecutive meeting after cooling inflation by intervening in the currency market.

The seven-day collateral lending rate was kept at 6 percent, Reykjavik-based Sedlabanki said today in a statement on its website.

Iceland said in February it would start buying kronur to help fight consumer price gains and take pressure off interest rates. Policy makers are trying to protect the currency from losses as they work to phase out capital controls in place since the island’s 2008 economic meltdown.

“The bank’s intervention in the foreign exchange market has contributed to reduced exchange rate volatility,” the bank said in the statement. Inflation expectations remain elevated because of “uncertainty” over foreign creditors, the settlement of the failed banks, capital control easing and wage negotiations, the bank said.

The krona has gained more than 6 percent against the euro from a low in January, helping bring inflation down to 3.9 percent last month, from more than 6 percent last year. The central bank raised rates six times from August 2011 to November last year to cool inflation after the krona weakened.

The government yesterday unveiled its first budget and said it expects a surplus next year as it raises taxes on banks. The income will in part be used to pay for income tax cuts. The central bank said in August it is “critical” that the state’s finances be brought into “balance as soon as possible.”

“Future fiscal policy has been clarified to some extent with the presentation of the new fiscal budget proposal,” bank said today.

Economic Outlook

The central bank’s August forecast shows the economy will expand 1.9 percent this year and 2.8 percent in 2014. Inflation will average 3.8 percent in 2013, 3.1 percent next year and won’t reach the bank’s 2.5 percent target until the second quarter of 2016, versus an earlier assessment for the end of 2014, the bank said then.

“According to first estimates, GDP growth in the first half of 2013 measured just over 2 percent, somewhat stronger than was assumed in the Bank’s August forecast,” the bank said. “The recovery of the labor market also continues.”

‘Action Plan’

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

Gunnlaugsson’s Progressive Party and his coalition partner, the Independence Party, ousted the Social Democrat-led coalition in April after promising tax cuts and mortgage debt 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.

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