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.