Iceland raises interest rates to secure loan

Iceland raised interest rates to a record 18 per cent from 12 per cent yesterday as a condition of a proposed $2bn loan from the International Monetary Fund to help rescue the stricken country.

Iceland applied to the Washington-based organisation for the emergency loan after its banking system collapsed and is seeking another $4bn (€3.2bn, £2.6bn) from some Nordic and other central banks.

The application will be presented to the IMF's board tomorrow and the central bank said a condition attached to the loan was for a rate rise to 18 per cent.

The move reversed a 3.5 per cent rate cut announced just two weeks ago by David Oddsson, central bank governor, underlining the influence the IMF now has over policymaking in Iceland.

Brian Coulton, managing director at Fitch Ratings, the credit ratings agency, said Iceland's central bank had "no choice but to work very closely with the fund".

Following the collapse of the banking system, the Icelandic economy is expected to contract by up to 10 per cent, unemployment to rise at about 8 per cent and inflation to hit 20 per cent or more, economists say.

"Putting up interest rates means they are going to go through the mother of all recessions, but the key is stability," Mr Coulton said.

The IMF-led rescue represents an important breakthrough for Iceland as it strives to stabilise its economy by clearing the way for other countries to come to its aid. But it has come at the price of agreeing to the organisation's demands. The IMF conditions attached to the loan are to restore confidence in the economy and stabilise the Icelandic krona, restore fiscal sustainability and re-establish a viable banking system.

Yesterday's rate rise was an important first step towards boosting the credibility of the Icelandic krona, which lost 70 per cent of its value during the crisis before trading dried up amid the uncertainty.

The IMF and Icelandic government have agreed that the currency should refloat within a matter of weeks, regarded as a vital step in restoring Iceland's international credibility and helping the international payment system to restart.

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

The huge interest rate rise came as Iceland continued to try to rally international support for multi-billiondollar loans to bolster its foreign exchange reserves, a move that should also help support its currency once it resumes trading.

The office of Geir Haarde, prime minister, told the Financial Times yesterday Iceland had sent an application for funds to the US Federal Reserve and the European Central Bank and had also been in contact with the Bank of Japan via its embassy in Tokyo.

The Icelandic krona is expected to be floated again as soon as is practical - possibly within the next two weeks - once the IMF's board has approved the $2bn loan.

By David Ibison in Stockholm

Published: October 29 2008 02:00 | Last updated: October 29 2008 02:00

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