Iceland Keeps Rate Unchanged as Strong Krona Damps Inflation

Iceland’s central bank left its benchmark interest rate unchanged for an eighth consecutive meeting after managing to cool 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.

“Inflation will be lower than previously assumed in the near term, but the outlook through 2016 is broadly in line with the previous forecast,” the bank said. “Inflation is expected to subside to target toward the end of 2015. Disinflation will therefore be slow and, as before, depend on near-term exchange rate and wage developments.”

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

The krona has gained about 6 percent against the euro from a low in January, helping cool inflation to 3.6 percent last month, from more than 6 percent last year. The central bank has raised rates six times since August 2011 to prevent krona losses from fueling inflation.

More Slack

The bank today forecast economic growth of 2.6 percent next year and 2.8 percent in 2015, down from earlier estimates of 2.8 percent and 2.9 percent.

“There was more slack in the system than they expected and therefore they raised rates too early,” said Asgeir Jonsson, an economist with Reykjavik-based asset manager Gamma. “However, there are indications that the economy is picking up pace, which can be seen in the construction and tourism industries. Therefore the bank won’t be lowering rates but I also don’t expect them to raise rates in the next six months, unless there will be some unexpected developments.”

Finance Minister Bjarni Benediktsson on Oct. 31 said he was optimistic that Iceland would soon be in a position to remove the restrictions on the krona, which are currently blocking about $7.2 billion in krona-denominated assets from being converted into foreign exchange. Removing the controls could take as little as six months, if expectations can be “aligned,” he said.

State Finances

The government in October 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’s “critical” that the state’s finances be brought into “balance as soon as possible.”

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.

The economy is seen expanding 2.3 percent in 2014 and 2.5 percent in 2015, the European Commission forecast yesterday.

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