The Icelandic government has stepped in to relieve pressure on the economy in a two-pronged strategy.

The Icelandic krona has been under increasing pressure on the foreign exchange markets recently due to the country’s limited supply of foreign currency reserves – a problem the government acknowledged when it allowed permission to borrow up to ISK 500 billion in foreign currencies at the end of May. At the time, it was not sure how much of that entitlement, if any, would actually be used.

There will now be a supplementary issue of treasury notes on the domestic market up to the value of ISK 75 billion. Experts in the Icelandic banking sector expect the auction to be well-received and for the yield on treasury notes to increase to a level closer to their long term average as a result.

The second part of the government’s relief package is a restructuring of the Housing Finance Fund (HFF), in an effort to reinvigorate the housing market. New measures will aid the banks and savings banks in providing and refinancing mortgages, while other measures will make it easier and more attractive for private customers to access HFF money directly.

It will now be possible for consumers to access mortgages with interest rates as low as 5.05 percent. Also, the fire insurance value reference for HFF lending will be discontinued, and instead the reference amount will be up to 80 percent of the purchase price of the property. The maximum HFF loan amount will be ISK 20 million instead of the previous ISK 18 million.

In a press release, Nordic bank Glitnir welcomed the developments, but stated that the government still has not gone far enough. “The measures are likely to have positive effect on markets in the short term,” the Bank believes. “But (at) the end of the day it will be the long term effect that matters the most.”

The Prime Minister of Iceland, Geir Haarde, said the economy could evade a recession forecast by the Ministry of Finance and the Icelandic Central Bank, reports Bloomberg.

“I am not so sure we will actually have negative growth rates,” said Haarde in Latvia last week. It is “one of the objectives of the government to ensure that we don’t go into a recession.”

Both the Ministry of Finance and the Central Bank have said the Icelandic economy will contract in 2009 after interest rates rose to a record 15.5 per cent in response to heightened inflation.

A 24 per cent drop in the Icelandic krona (ISK) against the euro this year has helped push inflation to an 18-year record of 12.3 per cent in May.

However, growing exports have slashed Iceland’s trade deficit to 600 million kronur ($7.7 million) in May from 7.3 billion kronur in 2007, boosting economic growth as imports slow.

Haarde said the krona “is more likely to come back up than go down. I think it will find a new equilibrium at a level quite a lot higher than it is now.”

The krona has fallen following concerns that the credit crunch may limit Icelandic banks’ access to funding, though Nordic bank Glitnir last week reported that the real exchange rate of the ISK rose in May according to figures from the Central Bank.

The Prime Minister’s comments follow moves by the Central Bank to increase its reserves of foreign currency. The government recently approved a bill allowing the bank to borrow as much as 500 billion kronur ($6.4 billion) in foreign currencies, equivalent to more than a third of Iceland’s GDP.

A research report published by Glitnir Bank has set out to demystify the future of the Icelandic economy.

The Nordic bank predicts that growth in the Icelandic economy will be negligible this year and next, but that the economy can expect to expand significantly in 2010 (3.8 percent) and 2011 (4.6 percent).

The two year cooling down period is contributed to the high price of oil and commodities, the global credit crunch and Iceland’s recent completion of large-scale industrial projects, as well as the recent cut in fishing quotas.

Inflation and slowly-increasing levels of unemployment will force down consumer growth. But cooling consumer demand and decreasing house prices will combine to allow the Central Bank to quickly lower the base rate.

Glitnir believes that the current 15.5 percent benchmark interest rate could be as low as eight percent by the end of next year, and that inflation will fall to the Central Bank’s target of 2.5 percent by mid 2009.

The full economic report is available at www.glitnirbank.com

The government of Iceland is currently considering enacting legislation to allow the country to borrow up to ISK 500 billion (USD 6.91 billion) in foreign currencies this year. The law is intended to secure the Icelandic krona and stabilise the Icelandic economy.

Iceland’s finance minister, Arni Mathiesen told Reuters: “We are proposing this legislation because we want to be in a position to react and be prepared for a crisis, should the situation on foreign markets change for the worse”.

This latest possible boost to Iceland’s economy comes just a fortnight after the deal with three Nordic central banks, allowing the country to swap kronur for up to 500 million euros if it needs to. The government said the deal was to bolster confidence in Iceland, and that it did not envisage taking advantage of the offer.

It is expected that if the legislation passes, the government will seek to make use of the facility. “”I cannot say when, but we expect to use at least a part of this authorisation to take a loan when situations in foreign markets allow us to do so,” Mathiesen said.

For more information on the Icelandic economy, see Glitnir’s recent research report at www.glitnirbank.com

The Icelandic krona could rise 8 per cent against the euro during the next few months, says a senior analyst at Bear Stearns investment bank.

Bear Stearns’ chief currency expert, Steve Barrow, believes the krona “has probably fallen enough” and predicts its value will bounce back to around 110 to the euro by July, according to a report in Bloomburg.

At one point the currency experienced a 35 percent fall against the euro since the beginning of 2008 but is now making up with modest gains. Losses against the dollar have been less severe at 12 percent in 12 months.

The experts at Bear Stearns retain their position of authority and the bank itself remains one of the big names on Wall Street, despite its emergency sale to JP Morgan earlier this year. Bear Stearns was a high profile victim of the global credit crunch, largely caused by defaults in the US sub-prime mortgage market.

Bear Stearn’s vocal support for the Icelandic krona will come as a surprise to some analysts. The US bank has been implicated in a possible plot whereby unscrupulous traders allegedly conspired to profit from an artificially induced meltdown of the Icelandic economy. The Icelandic government blames much of the recent negative market coverage on the country on misinformation provided by such investors.

Bear Stearns’s comments echo the sentiments of Icelandic finance minister, Arni Matthiesen, who spoke at a meeting in Hamburg last week. The minister stated that the krona is currently undervalued and that the worst of the crisis might already have passed.

The Icelandic economy is in less trouble than many media reports make out, says the Icelandic Minister of Finance, Arni Mathiesen, in a report by Reuters.

“The krona certainly was too strong, [but] now it‘s too weak. In the end it will come back closer to the average,” said the minister at a recent meeting in Hamburg.

Mathiesen went on to criticise ratings agencies’ recent downgrading of Iceland‘s credit rating, saying that the agencies are probably acting on media speculation, rather than the actual state of the Icelandic economy. “But then again the changes in the ratings aren’t dramatic,” he adds.

The Icelandic economy is experiencing a slowdown at the end of an unprecedented period of growth that has seen the north Atlantic island become one of the richest nations in the world. The country owes much of its success to the burgeoning banking sector.

Iceland’s three main banks, Glitnir, Landsbanki and Kaupthing, have seen several ratings cuts and a string of bad news since the New Year, but Mathiesen still sees a bright future: “I think [the banks'] position, with regards to how they are financed, is better than you would observe with banks generally in Europe or America.”

Iceland‘s economic ‘crisis’ has largely been fuelled by media speculation, but the minister believes that the situation will resolve itself as more hard facts come to light. In recent weeks, the Icelandic krona has stopped its downward spiral and has even seen modest gains.