Tags: Iceland | Cuts | Rate | krona

Iceland Cuts Rate to 6.25 Percent as Currency Caps Inflation

Wednesday, 22 Sep 2010 07:34 AM

Iceland’s central bank cut the benchmark interest rate by three quarters of a point after the island’s currency, sheltered by capital controls for almost two years, remained stable since the bank’s last decision, capping import prices.

Sedlabanki lowered the seven-day collateral lending rate to 6.25 percent, the Reykjavik-based bank said on its website today. The bank also cut the deposit rate to 4.75 percent from 5.5 percent. Policy makers have reduced the benchmark 12 times from a record 18 percent since obtaining a $4.6 billion loan from a group led by the International Monetary Fund at the end of 2008.

“The cut was in accordance with the hints the central bank has given,” said Ludvik Eliasson, head of research at MP Bank hf. It “could continue to cut rates,” though “how deep the cuts will be will depend on the economic developments. We can’t overlook that monetary policy also takes into account factors” including “the eventual removal of capital controls.”

The capital controls, imposed following the failure of Iceland’s three largest lenders in October 2008, have protected the krona from a sell-off. The currency has gained 21 percent against the euro since a Nov. 12 low, stemming consumer price gains. Inflation fell 0.3 point to 4.5 percent last month, the lowest rate in almost three years. Economic output slumped an annual 8.4 percent last quarter after contracting 6.3 percent in the three months through March.

The krona is little changed against the euro since the bank’s last rate decision on Aug. 11. It was down 0.4 percent at 153.93 against the euro at 9:42 a.m. in Reykjavik.

IMF Program

The IMF resumed its program with Iceland in April, freeing a $160 million payment. The lender’s third review of the island’s economic program is scheduled for Sept. 29. The fund delayed the review following a June 16 court decision banning some foreign loans that had threatened to derail the government’s debt reduction plans. The next review will also release about $160 million in funds.

In a subsequent ruling on Sept. 16, the island’s Supreme Court allowed Iceland’s lenders to charge higher rates on loans affected by the foreign-currency lending ban, potentially sparing them as much as $4 billion in currency losses.

The court’s decision last week will put the $12 billion economy on track to achieve a stronger recovery, central bank Governor Mar Gudmundsson said.

The bank may start easing capital controls after the third IMF review, Gudmundsson said on Sept. 20 following the sale of Kaupthing Bank hf’s FIH Erhversvbank to a group of Danish and Swedish investors. Sedlabanki will receive 255 million euros ($339 million) following that transaction. The bank had held the FIH shares as collateral for a 500 million-euro loan to Kaupthing before its collapse.

‘Easier to Remove’

“This amount is about double what we’re expecting from the International Monetary Fund after the third review of the economic program,” said Gudmundsson. “This will make it easier for us to proceed to remove the capital controls.”

The bank estimates foreigners are locked into about $3.4 billion in krona assets that have remained in limbo since the controls were imposed at the end of 2008.

Iceland’s economy will return to growth in 2011, when the central bank estimates output will expand 2.4 percent. Gross domestic product contracted a record 6.8 percent last year and will shrink a further 1.9 percent this year, marking the island’s longest period of economic decline since records began in 1944.

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Iceland s central bank cut the benchmark interest rate by three quarters of a point after the island s currency, sheltered by capital controls for almost two years, remained stable since the bank s last decision, capping import prices. Sedlabanki lowered the seven-day...
Wednesday, 22 Sep 2010 07:34 AM
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