iceland

Claire Jones

When IMF officials travelled to Iceland in the summer of 2008, they pronounced the health of its financial sector to be good.

The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient.

IMF, Iceland: Financial Stability Assessment – update, 19 August 2008

Within two months, the island’s three biggest lenders had collapsed, leaving its economy in tatters. Read more >>

Iceland’s central bank has just cut its interest rates by 25bp, leaving the key current account rate at 3.25 per cent. The Bank hasn’t stopped cutting since the financial crisis, though this is the smallest cut since 2002. Previous cuts have been monthly, and mostly half a percentage point (see chart).

The tiny island-state’s economy appears in relatively good shape. Inflation has fallen below the target of 2.5 per cent, and inflation expectations, which were nearing double digits, have fallen below 5 per cent. Indeed, with inflation at just 1.8 per cent, one might wonder why rates have been cut at all. According to the Bank, temporary factors were at play in pushing down January’s inflation:

One-off factors added to the seasonal drop in January. Favourable exchange rate developments over the past year, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation.

 Read more >>

Iceland’s central bank is still cutting rates – and further cuts lie ahead if inflation continues to fall. Sedlabanki said: “The appreciation of the króna, declining inflation expectations, and the slack in the economy continue to contribute to low and stable inflation… there may yet be some scope for further monetary easing.” November’s year-on-year inflation fell to 2.6 per cent – close to the 2.5 per cent target – down from 10.7 per cent in March.

With inflation expected to fall further, Iceland’s central bank will be wanting to head off any prospect of deflation. Lower rates will encourage debt-fuelled spending, which should drive prices up. The rate cuts – some 50bp, some 1pp, some 1.5pp – will also narrow the interest rate corridor to 2pp. This should help to reduce volatility in short-term interest rates. New rates are: Read more >>

Declining inflation expectations and a strengthening currency have prompted another substantial 75bp cut to Iceland’s key rates. The country has not stopped cutting since the financial crisis (see chart). No doubt the decision was supported by expectations of Fed easing, and the lower dollar that will likely follow.

Key rates are left as follows:

  • deposit rate (current account rate) will be 4 per cent
  • maximum bid rate for 28-day certificates of deposit (CDs) will be 5.25 per cent
  • seven-day collateralised lending rate will be 5.5 per cent
  • overnight lending rate will be 7 per cent.

Iceland’s central bank has also announced a revision to its strategy to lift capital controls. Read more >>

Iceland’s central bank has further reduced its key interest rates, this time by a blanket 75bp; the current account rate is now 4.75 per cent. The Sedlabanki cited an appreciating krona and falling inflation. Prices are still rising at an above-target pace, but the rate is forecast to fall below the 2.5 per cent target early next year.

The Committee considers that, if the króna remains stable or appreciates and inflation subsides as forecast, the premises for some further monetary easing should be in place. However, the prospects of capital account liberalisation create uncertainty about short-term room for manoeuvre. The MPC stands ready to adjust the monetary stance as required to achieve its interim objective of exchange rate stability and ensure that inflation is close to target over the medium term. Read more >>

Rapidly falling inflation and continued appreciation of the krona has prompted the Icelandic central bank to double its rate cutting to 1 percentage point.

Sedlabanki, the Icelandic central bank, has been cutting continuously since 2008, though held rates constant (as most banks did) during early 2009. Since then, rates have been cut in 50bp notches at consecutive meetings – half today’s cut. Read more >>

Rates have been lowered another 50bp in Iceland, justified by a rising krona and lower risk premia. Since the last MPC meeting, the krona has risen 5 per cent against the euro, “slightly more than assumed” by the central bank in its last forecast. Unlike last time, inflation is currently falling.

The central bank has also been repurchasing 2011 and 2012 euro-denominated bonds – €160m and €32m, respectively. The move is an effort to reduce reliance on external funding. Bilateral credit lines with Denmark, Finland, Norway, Poland and Sweden totalling €639m are being used to supplement the bank’s foreign exchange reserves.

On the subject of reserves, the bank explained:

Over time, the Central Bank will have to replace borrowed reserves with non-borrowed reserves. The appreciating króna and lower external risk premia could allow modest regular purchases of foreign currency. The timing and quantity of such purchases will be conducted so as to minimise the effect on the króna. No decisions on such purchases will be taken before the August MPC meeting.

 Read more >>

The central bank of Iceland has voted to lower interest rates by 0.5 percentage points. The deposit rate (current account rate) will be 7 per cent, and the maximum bid rate for 28-day certificates of deposit will be 8.25 per cent. The seven-day collateral lending rate will be 8.5 per cent and the overnight lending rate 10 per cent. See historical chart, right (source).

Icelandic inflation is on the up, with annual rates rising from 10.7 per cent in February to 11.6 per cent in March – almost an entire percentage point increase in just one month. Lower interest rates will make hot money flows – if any – reduce, but will also encourage credit-fuelled domestic spending to rise.

Bloomberg is reporting the following from Iceland’s Special Investigation Commission. The English translation of the report is not yet fully available:

Iceland’s government, central bank governors and head of the financial regulator in 2008 all showed negligence in breach of existing laws that allowed the collapse of the island’s financial industry, a report found. Read more >>

The strengthening krona and uncertain access to finances in the medium-term have pushed Iceland to cut its rates by 0.5 percentage points in spite of rising inflation.

The deposit rate (current account rate) will be lowered to 7.5 per cent. The maximum bid rate for 28-day certificates of deposit will be 8.75 per cent. The seven-day collateral lending rate will be 9 per cent and the overnight lending rate 10.5 per cent.