Iceland hikes interest rates to 18%

[mobes]

Iceland hikes interest rates to 18%
The rate rise means that investors get a much higher return for putting money back into the Iceland's crippled financial system

Iceland's central bank unexpectedly raised interest rates by 6 percentage points to 18% today as part of a loan agreement with the International Monetary Fund.

The move was designed to restore trust in Iceland's battered currency. After the announcement, the Icelandic krona traded internationally for the first time in a week.

The rate hike, which took rates to the highest since the Icelandic central bank began targeting inflation in 2001, came just a fortnight after borrowing costs were eased. Last week Reykjavik agreed a stand-by loan of $2.1bn (£1.33bn) with the IMF, but its prime minister said the country needs another $4bn.

Two weeks ago, the central bank cut rates by 3.5 percentage points to 12%. "This has come a bit out of the blue following the latest interest rate cut," said Elisabeth Gruie, emerging markets strategist at BNP Paribas. "And it reflects a desperate attempt to restore a degree of confidence in the local market and restore trading in the Icelandic krona, which has been completely frozen."

The island has been hit hard by the global financial crisis and three of its biggest banks have been nationalised.

The rate rise means that investors get a much higher return for putting money back into the Iceland's crippled financial system.

"It is of overarching importance to restore stability in the foreign exchange market and support the exchange rate of the crown," said the central bank, Sedlabanki.

Its governor David Oddsson said the rate rise was required before the IMF's board signed off the package, which is expected to happen on Thursday.

He admitted that Icelanders would suffer from higher borrowing costs. "This rate will obviously be very hard on the public and businesses. It should not come as a surprise given the enormous blow when 85% of the banking system collapses," he said.

But the central bank chief, a former prime minister who has faced calls to resign, said the island would bounce back. "At the end of all this, my guess is that the biggest surprise will be how fast we were back on our feet given the enormity of the blow."

Iceland's finance minister, Arne Mathiesen, said interest rates could come down again once the krona had stabilised.

Jon Harrison, an analyst at Dresdner Kleinwort, said the rate hike would help but more work was needed before people felt comfortable trading the krona. "That's started today, but it's still very illiquid," he said.

http://www.guardian.co.uk/business/2008 ... ch-iceland