The Central Bank of Iceland’s surprise six percent interest rate raise this morning to 18 percent is part of the deal agreed with the International Monetary Fund (IMF). According to chairman of the Central Bank, David Oddsson in a press conference this morning, raising interest rates is a sensible action to take at this time.
The reasoning behind the decision is, it would seem, almost entirely for the benefit of the IMF and the agreement Iceland reached with the fund last week. “The agreement, which will go before the IMF Executive Board for approval in the next few days, says, among other things, that the Central Bank should increase interest rates to 18 percent, which has now been done,” Oddsson said.
“This agreement is a reaction to the collapse of the banking system and the heavy external pressure that comes in its wake – which have served to paralyse the currency markets. Although the situation has improved slightly recently, the Central Bank’s principle objective is unavoidably to get the currency markets going again properly,” Visir.is reports Oddsson as saying.
The board of the Central Bank is concentrating its efforts on making the currency trade work normally again and to stabilise the Icelandic krona. The real exchange rate is much lower than Icelanders are currently feeling. It is therefore viewed as unavoidable to take action to stabilise the foundation of the krona on the international currency markets with increased interest rates ready for when the currency is re-traded without the current restrictions.
“Negative real interest could weaken that foundation,” Oddsson said. “A reduction in demand could lead to surpluses accumulating quickly on goods and service transactions with foreign countries.”
“Production stagnation and parity or excess in foreign trade will serve to increase the value of the krona, provided that trust can be returned to the currency markets. The plan, as it stands, is to reduce the base rate in harmony with the speed at which inflation decreases,” Oddsson explained.
“The real exchange rate is much lower than Icelanders are currently feeling”. What does that mean exactly? The euro should cost more than 150 isk?
“The real exchange rate is much lower than Icelanders are currently feeling”
It means that when I check hotel prices, I laugh. The Kroner isn’t worth anything close to what Icelandic merchants are representing the exchange rate to be.
wow 18% maybe we should put our savings in an icelandic bank LOL ;-)
Let me elaborate.
These exchange rates quoted here bear no relation to reality.
http://sedlabanki.is/?PageID=183
It may be the “official” exchange rate but the real rate, that is the rate that someone will actually pay for a Kroner, is no where close to the “official” rate. That’s what is meant by it is lower than Icelanders are currently feeling. One of two things must be happening. Either the govt of Iceland is using up reserves to support the “official” exchange rate (doubtful as they don’t have the reserves) or the trading in Kroner is frozen (likely).
Here we go again living in fairy fantasy tralalala land. Lend me your ears say the Icelanders, lend me more money.
Pls note that the IMF’s recommendations are the exact opposite of what the Icelandic central bank did initially! Does anybody believe this government knows ANYTHING about economics? It sure doesn’t look that way.
“Pls note that the IMF’s recommendations are the exact opposite of what the Icelandic central bank did initially! Does anybody believe this government knows ANYTHING about economics? It sure doesn’t look that way.”
The Iceland Govt/CB is subject to political pressure and that may, in the short term, override economic reality. However, once one goes hat in hand to the IMF one no longer has independent control of economic policy. That may explain the difference.
The current market rate in continental Europe for the krona is 280 ISK for 1 €. Iceland is able to maintain an higher rate at home because of the restrictions. That’s why you are not allowed to buy huge amount of foreign currency and send them abroad.
“That’s why you are not allowed to buy huge amount of foreign currency and send them abroad.”
Who is absorbing the differential between the fantasy “official” rate and the actual market rate?
And how long do Iceland merchants (hotels, tour companies etc…) think they can keep charging tourists the “official” rate? I’m sure no one is exporting goods at that rate?
What gives. What’s going on over there.
It’s curious. I hope Iceland can get out of this mess.
“Who is absorbing the differential between the fantasy “official” rate and the actual market rate?
And how long do Iceland merchants (hotels, tour companies etc…) think they can keep charging tourists the “official” rate? I’m sure no one is exporting goods at that rate? ”
The local banks partake in a daily auction to fix the rate. The Icelandic government then supplies the krona at the subsidised rate of around 150. To buy Euro’s the government would have to pay anywhere from 450 to the current rate which is 332 ( http://uk.finance.yahoo.com/q?d=t&s=EURISK= ) or use its 2Billion euro reserves.
The purpose of the IMF loan is (possibly) to continue this charade (the purpose of which is to keep voter happy and Politicians in power), however
any sort of fix won’t last, as the UK found out when it left the ERM.
looks like every one here is not looking at the true facts
The exchange rate is that rate being shown by the Icelandic Banks
Then there is a differant exchange rate in the Uk and believe me what your paying in England is totaly differant, the money changers in the UK are making a lot of money sellng Icelandic KR
So its simple dont buy Icelandic kr out side of Iceland and dont take the kr out of Iceland,
Right now Iceland will be making money on exporting products such as fish lamb energy, but they will not be bringing stuff in to the country,
they will be making money on tourists
I know for a fact life is not easy in Iceland i lived there for 20 years
@Alan:
WHAT?
Of course it is worth to buy icelandic crown outside of Iceland! Why pay 1 EUR per 150 ISK, if you can get it cheaper abroad? This is charade by icelandic central bank – they are burning their cash reserves and hoping they will “convince” people abroad that ISK is “worth more”. Well, it is simple law of supply and demand – NO ONE wants to *buy* ISK at 150, except for sedlabanki, but they only buy it from icelanders, and in small amounts.
The sad fact is, that the true market value of ISK is more close to 300 than to 150, but for the sake of providing the illusion a bit longer, sedlabanki will drain their reserves and buy ISK at a 200% premium.
Bid at Yahoo stands at 290 ISK/EUR, that means, there are people willing to sell ISK at 290 ISK per EUR. And NO ONE IS BUYING – the ask is at 335 ISK per EUR.
So, please, stop with this nonsense – you may get tourist boom which will really help your economy, but you will not get any tourist, when they learn that their EUR in Iceland is worth only half of the internation market value. And sedlabanki will get bankrupt, if they continue this for too long… so you will have few tourist and no foreign cash reserves.
“The Icelandic government then supplies the krona at the subsidised rate of around 150.”
Yeh, I assumed the only party that would possibly supply the subsidy was the Iceland govt. But it’s doin git indirectly with foreign money from the IMF.
But this can’t continue very long. Iceland will run out of foreign reserves or they they will have to stop all exchange out of Kroner.