Iceland holds rates as inflation has peaked: central bank

Iceland kept its key interest rate unchanged at 18 percent on Thursday, saying inflation had peaked at 18.5 percent and would rapidly decline after the country's economic collapse late last year, the central bank said. "Inflation appears to have peaked, and it will decline quickly in the period ahead," the bank, Sedlabanki, said in its monetary policy statement.
In 2008, the annual rate of inflation was 12.4 percent, after 5.0 percent in 2007. For 2009, it forecast 11.9 percent. The bank forecast inflation of 18.5 percent in the first quarter of 2009 and only 1.5 percent next year. It said prices had risen less than expected at the end of the year. "Inflation was lower than forecast in the fourth quarter of 2008, or 16.8 percent instead of the projected 19 percent," it said.
The bank also forecast the Icelandic economy would shrink by 9.9 percent this year, a gloomier outlook than in November when it predicted a contraction of 8.3 percent. "The central bank continues to forecast a sharp downturn in gross domestic product (GDP) and domestic demand in 2009. GDP is expected to contract by just under 10 percent during the year, rather more than was estimated in November," it said.
The growth forecast is also more pessimistic than that published by the government on January 20, which foresaw a contraction of 9.6 percent. Iceland's once booming financial sector crumbled under the weight of the world-wide credit crunch in October, forcing the government to take control of the major banks while its currency, the krona, lost almost half of its value in 2008.
The central bank said it expected the economy to continue to contract in 2010 but at a much slower rate of 0.8 percent, and predicted a turnaround to growth of 3.8 percent in 2011.
In 2008, Iceland saw growth of 2.0 percent despite the collapse of the financial sector, after registering growth of 4.9 percent in 2007. Before the crisis, which led to the downfall of Prime Minister Geir Haarde's coalition government earlier this week, Iceland was one of the wealthiest countries in the Organisation for Economic Co-operation and Development (OECD). It added that the Icelandic krona had appreciated by 10 percent in the past two weeks.