Surprise rise in Icelandic interest rates

Iceland’s central bank, the Sedlabanki, recently raised the Icelandic policy interest rate, making it the highest interest rate charged in any developed country around the world.

At the same time that the US Federal Reserve was slashing its interest rate by 25 basis points, the Sedlabanki raised its rate by 45 basis points to curb inflation. Interest rates in Iceland are now a record 13.75 per cent.

At the same time, the bank also announced that it would reconsider the interest rate in December, rather than the date that had been set in 2008. As a result of both announcements, the Icelandic krona went from 59.92 to the dollar to 58.79 to the dollar.

The announcement came as a surprise, even to many in the financial field. “Everyone thought the tightening cycle was at an end,” said Venla Sipila, senior economist at Global Insight in London. “The new December meeting suggests that they may be considering raising rates even further.”

Despite increasing inflation, driven by higher disposable incomes in Iceland, most were expecting the global credit crunch to play a larger role in the bank’s decision to leave the interest rates unchanged.

The new interest rate has already had an impact on the financial sector with share prices on the OMX Iceland 15 index trading lower since the change.

“On the one hand the decision highlights the fact that the risk of inflation remains, on the other hand it shows that the contagion in the market may not be as severe as people have been expecting, and could be contained,” said Sipila.