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Iceland c.bank holds rates, eyes on IMF deal

REYKJAVIK (Reuters) - The central bank of crisis-hit Iceland held its interest rate at a record high of 18 percent on Thursday as its prime minister said the country would have to wait for word on IMF help to rebuild its shattered economy.

Prime Minister Geir Haarde told Icelandic radio a meeting of the board of the International Monetary Fund to consider Iceland’s application for a $2 billion loan had been postponed until November 10 from this week.

Haarde said in this was to give Iceland more time to finalize other loans which are to be part of the IMF deal.

The prime minister also said Britain and the Netherlands wanted to make the IMF loan conditional on a settlement of refunds for depositors of failed Landsbanki’s Icesave bank.

“We do not accept that our cooperation with International Monetary Fund and the unfortunate Icesave affair be tied together,” Haarde said in the interview.

“The Fund’s director has asserted that our application will be treated in a normal fashion and according to the rules. I am confident that will be the case.”

Britain’s finance ministry and its Dutch counterpart declined to comment.

Earlier on Thursday, the UK said it would lend 800 million pounds ($1.27 billion) to a compensation scheme for its savers, who put about 4 billion pounds in Icesave accounts.

Iceland has agreed to pay Dutch Icesave clients up to 20,887 euros ($26,840) each with a Dutch guarantee covering amounts up to 100,000 euros. The Dutch will lend money to Iceland to help fund the compensation scheme.

Haarde said in a Reuters interview this week that Iceland would pay “every penny it legitimately owes.”

STABILITY

Iceland’s central bank last week hiked rates by a massive 6 percentage points as part of a provisional deal with the IMF.

Despite record interest rates, the central bank said in its Monetary Bulletin on Thursday it saw inflation -- at 15.9 percent in October -- rising even further in the coming months to top 20 percent in early 2009.

It added the country faced a severe recession which would lead to unemployment rising to around 10 percent by the end of next year. Unemployment was 2.5 percent in the third quarter.

“It is clear that developments in the exchange rate will have a decisive effect on the depth and duration of the recession and the time required to regain control of inflation,” the Sedlabanki said.

“For this reason, the central bank will concentrate on achieving exchange rate stability as soon as possible.”

Key to restoring faith in the krona will be money from the IMF and $4 billion Iceland said it wants from other lenders.

“We are awaiting the loan deal with the IMF and the Nordic countries,” said Carl Hammer, foreign exchange strategist at SEB. “Focus is then on what measures and conditions it will contain. I think the IMF and the Nordic countries will present a joint package by tomorrow night.”

The central bank said it expects a final decision by the IMF board on an aid package very soon.

SHATTERED

Iceland, home to just 300,000 people, has seen its economy devastated by the global financial crisis.

The collapse of three of the country’s biggest banks alone could cost as much as 1.1 trillion Iceland crowns ($8.6 billion), according to the prime minister.

This would be equivalent of 85 percent of the country’s gross domestic product in 2007. The economy is expected by some to shrink 10 percent next year.

Iceland has sought help from a variety of sources, including its Nordic neighbors, Russia, Japan and the European Union.

Norway said this week it would give Iceland a 500 million euro ($644 million) loan.

The rate decision on Thursday had been widely expected, with the cost of borrowing likely to remain high for some time to counter inflation and support the currency.

The Sedlabanki said if it succeeds boosting the currency, inflation could fall rapidly and with it interest rates.

Its baseline scenario sees the crown strengthening to 134 per euro in the fourth quarter 2009. The crown was trading internationally at about 200 to the euro on Thursday although only three trades were made. Iceland’s central bank fixed the price at 166 crowns to the euro on Thursday.

(Reuters monitors official news on Iceland via its Stockholm newsroom.)

Writing by Niklas Pollard and Simon Johnson; Editing by Victoria Main and Andy Bruce

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