Iceland's Finance Minister Urges Rate Cuts as Krona Controls EndBy and
Central bank keeps rates unchanged on growing demand pressures
Bank says will ‘mitigate’ short-term krona volatility
Iceland’s central bank should cut interest rates again to relieve pressure on the krona in conjunction with the dismantling of the capital controls, the nation’s finance minister said.
With controls gone and the labor markets calm, it’s set up for the central bank to reduce interest rates “somewhat,” Finance Minister Benedikt Johannesson said, adding that he of course has no “influence” over such a decision. The government has taken steps to reduce pressure on the economy to avoid an overheating, in part by increasing budget surpluses, he said in an interview on Bloomberg TV.
Johannesson’s government on Tuesday ended the nation’s eight-year capital control regime, giving its citizens, companies and pension funds full access to the global markets. But the central bank on Wednesday failed to deliver on the minister’s wishes, keeping its benchmark rate unchanged at 5 percent, citing growing “demand pressures.”
“It’s too early to predict the economic impact of the most recent steps in the capital account liberalization process,” the bank said. “It’s possible that a better balance will develop between foreign exchange market inflows and outflows, but short-term volatility could increase, as appears to have happened in the past few days. The Central Bank will continue to mitigate short-term volatility when conditions warrant it.”
While the krona slid almost 3 percent on Monday and bond yields move higher, the currency recovered late on Tuesday in Reykjavik. It also rose 0.4 percent to 116.97 per euro as of 9:24 a.m. in Reykjavik.
The government said it hopes that the steps will cool pressure on the currency to appreciate by allowing more investments abroad by pension funds. The currency has risen about 17 percent against the euro over the past year, boosted by a record inflow of tourist.
“The main reason for the krona gaining strength is the tourism boom,” Johannesson said. “I think lifting capital controls may be a way to at least stop this trend.”
The krona is now in “full float” with some “precautionary measures for inflows,” he said.
The economy last year surged 7.2 percent, driven by household spending and investments. Unemployment is down at about 3 percent and inflation is under control. The krona has also rallied in part as traders have been attracted to the nation’s higher interest rates.
One can “never say never” on whether Iceland will go through another crisis, Johannesson said. “But with the precautions now both legislative and financial we are in much better shape.”
Government debt is down, the nation has currency reserves like “we could never dream of before” and the banks are much smaller than in 2008, he said.
“We’re not dreaming of being an international banking superpower as we were,” he said.