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Guest Commentary: In a Parallel World, Iceland Hikes Rates to Battle Inflation

Guest Commentary: In a Parallel World, Iceland Hikes Rates to Battle Inflation

2012-06-15 04:00:00
Yohay Elam, Forex Crunch,
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Many countries in the developed world have very low interest rates for a long time. The US, UK, Japan, Germany and Switzerland also enjoy record low long term yields.

However, a country on the edge of Europe, took a different approach in tackling banking issues, and is now raising the rates: Iceland.

Iceland is experiencing "robust" domestic demand according to its central bank. This is the main reason for hiking the rates by 0.25% to 6.75%. Inflation is also low due to the weak currency. The central bank also hopes that the currency will strengthen. Yet again, while many other countries are in a race to the bottom with devaluing their currencies, Iceland prefers a stronger currency.

Here's a quote from the rate statement, which is so different from other central banks' statements:

National accounts data for Q1/2012 are broadly in line with the Bank’s May forecast, which stated that GDP growth would continue to reduce the margin of spare capacity in the economy. The economic recovery is broadly based, and the growth in domestic demand is robust. Signs of recovery in the labour and real estate markets are steadily growing stronger.

Iceland had a bloated banking sector which collapsed at the end of 2008. Instead of pumping money into the banks, Iceland eventually let the banks fall. The economy fell as well, together with all the world, but recovered very quickly and is now experiencing growth and inflation.

In a week that sees Spain getting money for its banks, the comparison (which many Spaniards do) is staggering. So, Spain is following the Irish path of taking over the banks and seeing its finances and its people suffer.

Nevertheless, there are quite a few differences: Spain is a much larger economy, and is a member of the euro-zone, so it cannot devalue the currency to boost exports.

Further reading: 8 Holes in the Spanish Bailout

By Yohay Elam, Forex Crunch

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