November 27, 2012 / 9:56 AM / 5 years ago

Iceland gov says still risk to rates from wages

ABU DHABI, Nov 27 (Reuters) - Iceland’s central bank could still raise interest rates further in response to any major rises in wage settlements, although it is probably finished with hikes in the near term, its governor Mar Gudmundsson said on Tuesday.

The bank raised rates earlier this month by 25 basis points to 6.0 percent but said it should be enough to rein in inflation that has been pushed higher by a 10 percent slide for Iceland’s crown currency against the euro since August.

“When we say that we are done with interest rate rises, then we are looking at the baseline forecast...” he told Reuters on the sidelines of a financial sector conference in Abu Dhabi.

“But there is a proviso there. We said it’s contingent on revision of the wage contracts being consistent with inflation going down to target. If it does not happen, we might not be done.”

Gudmundsson added: “We are forecasting inflation to come down but it depends what the explanation is. If there is revision of wage contracts and wages increase much more than is consistent with our inflation target, then we might consider rate hikes.”

Earlier this month, the central bank cut its growth forecast and said the economy was recovering more slowly from a financial meltdown in 2008, when its top banks collapsed in the span of a single week. But inflation remains over its target of 2.5 percent, running at an annualised 4.2 percent in October.

The International Monetary Fund said in a review of Iceland’s economy last week that capital controls, originally imposed in 2008 during the country’s financial crisis, would probably only be eased from 2016.

Gudmundsson said, “It’s a bit more complicated than that. We will be probably easing controls somewhat. There is a bill in parliament that foresees easing of some controls, not in a major way.”

In terms of abolishing most of the controls, “the IMF’s guess might be as good as anybody else‘s”, but this would require a very significant turnaround in capital flows, he said.

Gudmundsson said that in early 2009, about 600 billion Icelandic crowns, equivalent to almost 40 percent of gross domestic product, were held offshore by the country’s foreign creditors in liquid forms such as bank deposits and short-term government bonds.

He said the level has now been reduced to 23 percent, but 200 billion crowns could be added to the overhang when failed banks make more payments to creditors, helping to boost the total that could potentially be exchanged into foreign currencies - weakening the crown - back towards 600 billion.

This repayment process by banks could take “probably at least two or three years”, and Gudmundsson said 600 billion is not a level that he would be comfortable.

But he added, “However, let’s wait and see - we are now dancing a tango with the creditors and there might be some kind of arrangement.”

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