Just Testing the Water

Today the Central Bank lowered the prime interest rate 1% from 18% to 17%.  Vilhjálmur Egilsson, managing director of Samtaka atvinnulífsins said this change was an "unbelievable small decrease" and would have liked to have seen the rate dropped to 10%.  A look at the exchange rate for the kronur today shows that the 1% drop was a prudent move by the Central Bank.  The kronur has continued its slide downward today by about 1.4% with the drop in the prime interest rate certainly not helping to slow the decline.  The Central Bank, in its press release today, sees the need to lower interest rates by understands something Vilhjálmur does not; a quick drop in the rate will mean a quick depreciation of the Icelandic kronur. 

Lower interest rates would be good news for individuals and businesses that have regular, non-index linked loans.  But any furthur weakening would be a distaster for those who have foreign currency loans.  These loans have already seen increases in payments of 60- 80%.  And a weak kronur will also increase the cost to import to Iceland adding more to the already high inflation rate. This will be felt by conumers in the shops and homowners who, as a majority, have inflation linked loans and have already felt an 18% increase in the principle portion of the payments . 

The high risk of lowering the prime interest rate too quickly far outweighs the savings that will be seen in non-index linked loans.  The high  prime interest rate has kept a lid on a predicted higher inflation rate and has given some strength to a battered kronur. The Central Bank was just sticking a toe in the water to feel the temperature.  Anything more than a toe and one risks being burned.

 GTB 

„Ótrúlega lítil lækkun"