Iceland's economic woes deepened on Friday after inflation jumped sharply in March to a six-year high of 8.7 per cent from February's 6.8 per cent, well over the central bank's target of 2.5 per cent. ( FT )
The increase was due mainly to the rapid depreciation of the Icelandic krona, which has lost almost a third of its value against the euro this year, as well as rising goods prices in world markets and wage increases.
Rapidly increasing prices will add to the pressure on the central bank to increase interest rates when it next meets on April 10. In an emergency move, it raised rates earlier this week by 1.25 percentage points to a record 15 per cent. At these levels Iceland's rates are the second highest in Europe after Turkey at 15.25 per cent. The central bank has been lifting rates to try to tame inflation and restore confidence in the krona.
"Price increases brought on by depreciation of the Icelandic krona seem to be surfacing rapidly and faster than in normal conditions," said Glitnir Research. It expects inflation to increase further to 10 per cent in April.
These moves have been needed as Iceland's economy has expanded rapidly in recent years, creating a cocktail of macroeconomic imbalances that have eroded investor confidence.
Among these are a current account deficit of 16 per cent of gross domestic product in 2007 and concerns over the fast growth and internationalisation of its banking system, which was paid for with high levels of debt.
Banking assets now account for almost 10 times the small nation's GDP compared with just 96 per cent of GDP in 2000.
But with rising interest rates having little effect at the moment, there are expectations in the market that the authorities in Iceland may take additional measures to inject liquidity into the financial system.