Iceland's central bank cuts rates again despite Icesave

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Iceland's central bank trimmed interest rates again on Wednesday to ease conditions for borrowers hit by a slumping economy and said there could be room for more cuts ahead.

Despite continued recession, markets had been uncertain over whether the Sedlabanki could lower rates further as it grapples with a dispute over debts to Britain and the Netherlands, an issue that has threatened to hold up much-needed financial aid.

But inflation has been falling -- month-on-month prices fell 0.3% in January - and more than a year after the financial system collapsed, the economy is still a wreck.

"If the krona remains stable or appreciates, and if inflation continues to fall as forecast, there should be scope for continued gradual monetary easing," the central bank said in a statement.

It added it would have limited room for manoeuvre while access to foreign capital remained uncertain, a reference to the so-called Icesave row with Britain and the Dutch.

Earlier in the day, the Sedlabanki said it would cut its key rate by 50 basis points to 9.5%.

"It's a little bit surprising given the political uncertainties," Lars Christensen, analyst at Danske Bank said.

He said falling rates would make it hard for the central bank to remove capital controls, imposed at the height of the crisis to protect the fragile currency, but now seen as a bar to returning to the international financial markets.

"Indirectly, this is a signal that capital controls will not be removed for some time," Christensen said.

Crash

Iceland's banking system, currency and economy crashed late in 2008, victims of the global credit crunch. The island of just 320,000 was forced to go to lenders, led by the International Monetary Fund, for aid to revive its financial system.

But recovery -- and access to overseas capital -- has been held up by a dispute with Britain and the Netherlands.

Icelanders will vote on March 6 on whether to accept a bill setting out the terms for repaying more than USD 5 billion the UK and Dutch handed out to savers who lost money when Iceland's banks collapsed.

Without a solution to the issue, further economic aid is likely to remain stalled and Iceland badly needs the money.

The central bank forecast the economy contracted 7.7% in 2009 and would fall again by 3.4% in 2010, a worse decline than it had previously expected.

"Economic recovery will begin one quarter later than assumed in the last forecast," the central bank said, adding quarter-on-quarter growth would be positive in the April-June period this year.

Annual growth will return in 2011, when the economy is seen expanding 2.6%, but the central bank saw weaker growth than previously expected the following year.

"In 2011, however, more robust growth in domestic demand will result in half a percentage point more GDP growth than was forecast in November, while the more negative contribution from net exports in 2012 partly explains the lower GDP growth forecast for that year," the central bank said.