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UPDATE 2-Iceland central bank leaves key rate unchanged as capital controls end
March 15, 2017 / 9:43 AM / in 8 months

UPDATE 2-Iceland central bank leaves key rate unchanged as capital controls end

(Adds analyst comment, comment by bank governor, crown reaction)

REYKJAVIK, March 15 (Reuters) - Iceland’s central bank left interest rates unchanged at 5.0 percent on Wednesday and hinted it may lower them soon if an end to capital controls doesn’t undermine the country’s currency.

The controls, imposed during the 2008 financial crisis, were lifted this week, and on Monday the crown plunged in its biggest one-day decline for eight years. But it rebounded on Wednesday, gaining around 1 percent against the euro by 1235 GMT .

Central bank Governor Mar Gudmundsson said the threat of an overheating economy and volatile currency had led the central bank to keep rates unchanged. But he held out the possibility rates would fall.

“In the same way that the equilibrium exchange rate of the krona has got higher, there are strong indicators that the equilibrium real interest rate has got lower - that we don’t need as high a real interest rate as before to reach our inflation target,” Gudmundsson said.

A tourism boom helped Iceland’s economy grow 7.2 percent in 2016, raising concern inflation would accelerate. But so far a robust crown has kept inflation under control, allowing the central bank to ease borrowing costs.

“We think that the outlook for monetary policy will depend mainly on the direction of the krona,” Capital Economics economist Stephen Brown said in a note.

“The recent drop in the krona reduces the need for the CBI to cut interest rates soon. But with the krona set to rise again before long, we still expect a rate cut later this year.”

Inflation has been below the central bank’s 2.5 percent target since early 2014. It was 1.9 percent in February .

The central bank’s most recent policy move was a quarter-point cut in December to counteract a strengthening crown.

Scrapping the controls means the central bank will have to stay alert for further shifts in the currency. Regulations and reserve requirements will remain in place to keep an influx of foreign investment from distorting the exchange rate. But Gudmundsson said eventually they should be removed as well.

“Going forward, the idea is not that the special requirement on inflows into the bond market will always be active,” he said.

“That will depend on what is happening and where the risk is building up in the system, how high the positions are, what is happening in monetary policy and the economy.” (Reporting by Ragnhildur Sigurdardottir in Reykjavik; Stine Jacobsen and Nikolaj Skydsgaard in Copenhagen and Daniel Dickson and Simon Johnson in Stockholm; Editing by Larry King)

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