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By Sujata Rao
LONDON, March 13 (Reuters) - The Icelandic crown posted its biggest one-day fall in eight years on Monday after the government said it would lift all remaining capital controls this week, a move that could trigger initial outflows of pent-up foreign and domestic money.
The finance ministry said on Sunday that in the following week it would lift all remaining capital controls that affect individuals, firms and pension funds. Iceland had already started dismantling capital controls for local residents last year.
The move could eventually bring more cash into Icelandic markets, where five-year bonds pay yields of almost 5 percent and data recently showed the economy growing at over 11 percent, the fastest pace in 10 years.
But on Monday, the crown fell around 3 percent versus the euro to three-week lows of almost 119 per euro, also falling by a similar amount to the dollar.
However, it had earlier this month hit a near-nine-year high to the euro, thanks to strong tourism receipts, and Jakob Christensen, a strategist at Danske Bank, said authorities would be pleased to see the currency weakening.
"Some crown weakening is probably expected and desired by the authorities. Expected, because there is a bit of pent-up demand for foreign assets within Iceland. Desired, because... the crown has probably been getting to levels where the authorities are starting to feel uncomfortable," Christensen said.
"The issue (for investors) has been the possibility of getting money out, and there have also been restrictions on Icelandic pension funds' ability to invest abroad."
Under the new rules, citizens will no longer be required to repatriate foreign currency and pension funds can be invested abroad without restrictions.
"This isn't necessarily a sign that the crown is about to depreciate sharply, rather we think it will stem the upward pressure on the currency," said Stephen Brown, European economist at Capital Economics in London.
Icelandic stocks jumped 1 percent, while crown-denominated bonds were flat on the day, according to data from the Icelandic debt agency.
The tiny country of just over 300,000 people resorted to capital controls after its three biggest banks collapsed and the crown fell more than 30 percent in 2008. That trapped many foreign investors who had flocked to Iceland, lured by its high yields.
Analysts at Iceland's Arion Bank noted that special reserve requirements would stay in place to prevent a resurgence of huge inflows to Icelandic bonds from foreign yield-seekers.
"Therefore, new foreign capital inflows to crown-denominated bonds seem unlikely," they told clients, adding: "The restrictions that are being lifted induce capital outflow in the short term." (Additional reporting by Karin Strohecker, Niklas Pollard and John Geddie, editing by Pritha Sarkar)