Jyske Bank offers regular economic analysis and updates.
For current information go to www.jbpb.com
Their
July 14, 2006 analysis of Iceland’s economy
maintains a neutral view on Iceland. The bank expects more
turbulence over the coming period.
Jyske says that Icelandic interest rates are up and that
there will be an extraordinary meeting in August of the central
bank (Sedlabanki).
They stated that on 6 July,
the interest rates rose 0.75 percentage points to 13%. This
is 7.7% higher than May 2004 when rates were at an all time
low for the last decade.
The next meeting of the central bank had been scheduled
for 14 September, but due to inflation an extraordinary meeting
has been set for August 14, 2006.
Jyske states that they expect interest rates to be raised
again at that meeting.
The central bank publishes an inflation report three times
a year, and the first this year had a hawkish tone about
fighting inflation. The upcoming appears to be even more
hawkish.
Jyske says that according to the bank, the inflation prospects
have deteriorated and inflation is accelerating at an unacceptable
pace, given continued high demand and major investment activity
in Iceland.
Inflation appears to be growing from its 8.1% rate in June
2006. The central bank increased its its inflation forecast
and expects inflation towards the end of 2006. The bank now
expects inflation to remain high until mid-2007 and has raised
interest rates by 2.5 percentage points in 2006 to slow this
increase.
However with the increased inflation real interest rates
are essentially unchanged. This could mean there will be
evn more rate hikes this year.
The weakening krona continues as a result of the imbalances
of the Icelandic economy and reflects lower confidence in
the stability of the financial system.
The falling krona fuels inflation since so many items are
imported. Any further bad news in the economy could thus
cause a further weakening of the currency and thus intensify
inflation which could lead to even higher interest rates.
The unanswered question is how much should interest rates
be raised? And why is inflation growing so quickly and how
high will it go?
The answers to how high will inflation run and how high
should rates be raised are difficult to predict. Iceland
has a small economy, but interest-rate hikes have a slow
impact on consumption and house prices because wages and
employment are at a historical high, and most housing loans
are long-term fixed interest-rate loans.
Housing
is one key in the inflation. Competitive mortgages
and shortage of houses has pushed house prices sup over the
last two years. This directly increases inflation.
The
monetary policy of Iceland’s central bank (as
opposed to the European central bank and the US Fed) uses
an inflation index that includes actual housing prices. This
is possible in practice since Iceland’s housing stock
is relatively small, and traditionally the housing market
has been strictly regulated.
The EU index reflects expenses for rental and maintenance
of houses, not actual property prices.
If housing
increases were not included inflation did not rise until
April after the weakening of ISK. In other
words, the latest rise in inflation from April to May reflects
the real effect of the ISK weakening on housing prices, and
it is not until now that this index does not comply with
the inflation target.
When the central bank increases rates to slow inflation
as it requires a fall in house prices to show success. This
could crate a recession instead of a soft landing.
The government recently proposed an economic program to
slow the economic growth which was 8.2% in 2004, 5.6% in
2005 and is projected to be above 4% in 2006.
The
government’s plan reduces public investment and
eliminates some tax cuts and restricts credit.
Jyske Bank feels this is a positive signal.
In the mean time there is added pressure and the Euro Icelandic
krona EUR/ISK rate is close to a new test around 99.50.
Jyske Bank feels that before this happens, the EUR/ISK rate
will meet resistance around 97.50.
Jyske expects the negative tone to continue and if the EUR/ISK
rate goes higher than 98, it is time to get out of the korna.
Jyske wants to see the EUR/ISK rate go below 90, before they
recommend investors to buy ISK.
EUR/ISK is currently trading at 96.50.
Despite
the risk of a further weakening of ISK, this is a currency
to watch and be ready to invest in. The central bank is
tightening hard to control inflation and if the government
introduces the fiscal-policy measures it is proposing, inflation
will slow and the market’s negative sentiment about
the krona will disappear.
At that time an investment in Icelandic bonds may prove
a profitable investment for the active investor. There is
a yield in the 11% range and this with a steady currency
will be attractive.
Join us at Merrily Farms and learn more about the Icelandic
krona and other currencies and international investments.
One of the waterfalls at Merrily Farms.
P.S. Learn more about how to invest
globally. Join Merri, Thomas Fischer from Jyske Bank Copenhagen
and Steve Marchant from Ecuador and me at our next International
Business and Investing Made EZ course in North Carolina.
Our free accommodations here on the farm are reserved on
a first come first served basis so do not delay! More
Details Available
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