Western Europe Just Got Its First Interest-Rate Cut This Cycle

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Iceland just became the first western European country to cut its interest rates, as everything from an airline bankruptcy to the risk of a no-deal Brexit darkens its economic outlook.

The central bank in Reykjavik cut its main rate by half a point on Wednesday, to 4%. Policy makers also warned the economy was now set to contract, as they abandoned a previous forecast for 1.8% growth in 2019. Just six months ago, policy makers were still raising rates.

Read More: Wow Air Collapse Triggers Recession and Rate Cut in Iceland

Iceland’s central bank governor, Mar Gudmundsson, said the economic impact of Wow Air’s collapse in March was considerable. The company “had in fact shrunk to half its former size before it went bankrupt.”

“It was clear that the economy was going through a rapid cooling and that there was not a cause for tight monetary controls,” he said.

Gudmundsson said the measures Iceland took after the 2008 meltdown have created buffers that will help it through the current downturn, including substantial foreign currency reserves. That’s helped anchor inflation expectations, he said.

During the previous crisis, “everyone expected a great devaluation of the exchange rate, which would increase inflation, and everyone rushed to the store to buy refrigerators and cars and such,” Gudmundsson said. “We are not seeing this today because both the exchange rate expectations and the inflation expectations are much more in tune with the target.”

Iceland has replaced it exposure to an outsized finance industry with a reliance on its tourism and export industry. Its biggest trading partner is the U.K., meaning the prospect of a messy exit from the European Union could force Iceland to cut interest rates again, Gudmundsson said.

“A no-deal Brexit will have a negative impact on growth in Britain, which is our biggest trading partner,” he said. “That would mean a further shock for our exports, which would influence the exchange rate negatively, which would perhaps increase the contraction somewhat. Then our rates would go somewhat down to react to that.”

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