Iceland Sedlabanki Keeps Benchmark Rate at 12% to Support Krona
Iceland’s central bank left the benchmark interest rate unchanged as policy makers try to support the currency before capital restrictions are scaled back later this year.
Reykjavik-based Sedlabanki kept the repo rate at 12 percent, according to a statement on its Web site today. The bank has lowered the rate four times this year from a record 18 percent since obtaining a $5.1 billion loan from a group led by the International Monetary Fund.
Iceland’s economic collapse, sparked by the failure of its biggest banks in October, forced the island to impose capital controls to prevent a sell-off of the krona at the end of last year. Restrictions failed to prevent a 7.9 percent krona decline against the euro this year and the IMF has warned that the central bank needs to focus on keeping the currency stable as Iceland targets relaxing capital controls from November.
“The central bank’s main focus is on maintaining the rate of the krona, which should limit the chances of policy rate changes into the second quarter of 2010,” Ingolfur Bender, head economist of Islandsbanki, said before the announcement.
At 12 percent, Iceland’s benchmark is Europe’s joint highest, together with Serbia’s two-week repo rate.
Iceland’s currency is undervalued, Governor Mar Gudmundsson said in an Aug. 26 interview, and the bank’s main challenge is to “find opportunities” to lower rates without harming the krona as capital controls are eased. The bank hasn’t ruled out raising interest rates to prevent the value of the krona from decreasing, once capital controls are removed.
Stricter Surveillance
The central bank announced on Sept. 18 that it would impose a stricter surveillance of the island’s capital restrictions, after breaches weakened the currency. The bank is investigating “dozens” of violations of the capital controls, it said then.
The krona rate will average 169.2 against the euro this year and 168.9 in 2010, the central bank said on Aug. 13. That compares with 183.01 against the euro yesterday and an average rate of 180.52 since the end of June.
Iceland will allow new investors to avoid capital controls starting Nov. 1, provided the island meets a set of economic conditions, including stabilizing its financial system and currency, the central bank said on Aug. 5. Controls will be lifted in two stages, with the first step allowing foreign- currency inflows linked to new investments to circumvent controls and the second step freeing long-term outflows.
Drive Policy
Franek Rozwadowski, the IMF’s representative on the island, said in a July 2 interview that the target of keeping the krona stable is “what should drive monetary policy.”
Inflation slowed to an annual 10.9 percent in August, from 11.3 percent in July, the statistics office said on Aug. 27.
The central bank expects inflation to approach its 2.5 percent target early next year, it said on Aug. 13. There is also the “possibility” of “temporary deflation” in late 2010 and 2011, the bank said.
The central bank estimates Iceland’s economy will contract by 9.1 percent this year. Household spending will slump 19.7 percent and fixed investment will plunge 48.4 percent, according to the bank.