Iceland Prepares Measures to Quash Speculative Krona Trading

As Iceland prepares to rejoin the club of countries with open economies, the island’s central bank is drafting proposals that will allow it to keep the door shut for carry traders hoping to make a quick buck.

The bank’s drive comes after it raised its benchmark interest rate for a third time since June, hitting 5.75 percent and driving it further away from the unprecedented low, and even negative, rates dominating the rest of western Europe.

Higher yields are once again making Iceland a magnet for investors that borrow in low-rate currencies and carry them into the island’s economy. A similar inflow of capital was instrumental in helping cause the financial instability that triggered its 2008 collapse. Since May, foreign investors have snapped up 49 billion kronur ($377 million) in nominal Treasury bonds, or about 7 percent of the outstanding stock, pushing down yields.

"It’s no secret that we’re seeing certain cracks in the monetary policy process because of these inflows," Governor Mar Gudmundsson said in an interview Wednesday in Reykjavik.

Chart of Yield development for Iceland's 2019 notes.

Iceland’s krona has strengthened about 5.7 percent against the euro from mid-June. It was little changed at 141 per euro as of 7:45 a.m. local time.

Iceland is raising rates to rein in inflation as the island completes its resurrection amid plans to ease capital controls next year. Economic growth is now faster than in the euro zone on average and inflation will move above the central bank’s target next year as wage growth soars, according to the bank.

To stem the inflows, Gudmundsson said the bank is working on proposals that will allow it to reduce investors interest in short-term krona positions. Iceland could choose to tax carry traders or impose minimum reserve requirements with very low or no interest.

"We’ve yet to decide how this will be executed but in reality it will have an impact on the profits from the carry trade," he said. "We don’t need to put this to a complete stop but we need to damp this -- it will have to be decided by the circumstances. We’re not opposed to -- in general -- that foreign parties have faith in Iceland and want to take a long term position."

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