Iceland’s Central Bank Eases Somewhat Unexpectedly

January 27, 2010

Much of the statement released by the Central Bank of Iceland after a 50-basis point cut in key interest rates is devoted to the ongoing debt dispute and uncertainty over the country’s future access to foreign capital markets.  The debt crisis took a turn for the worse when Iceland’s president recently vetoed Icesave legislation on an accord to restructure debt owed Dutch and British creditors, which triggered a downgrade of Iceland’s credit rating and may stall aid from the IMF.  Nevertheless, today’s rate cut was justified by lower inflation and krona stability, the latter fostered by capital controls.  Moreover, the statement leaves the door open to further rate reduction if these two conditions (falling inflation and a steady exchange rate) persist.  CPI inflation excluding the impact of higher consumption taxes is down to 5.2% after having fallen more than assumed in December and January.

The statement however warns that the central bank’s room for maneuver has been curtailed by the debt crisis.  From a high of 18% after an IMF-mandated 600-basis point rate hike in October 2008 intended to stabilize the krona, the central bank implemented rate cuts of 100 basis points in March 2009, 150 bps in April, 250 bps in May, 100 bps in June, 100 bps in November and 100 basis points last December 10th.  But today’s cut in the key seven-day lending rate to 9.5% from 10% was by only 50 basis points, the smallest move in the cycle of reductions.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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