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Iceland faces a lower risk of speculative money flows because of shifts in global monetary policy after Russia's invasion of Ukraine, central bank Governor Asgeir Jonsson said.
With counterparts from the U.S. Federal Reserve to the euro zone acting against inflation risks, the north Atlantic island nation no longer stands out in the way that it did last year when it became western Europe's most aggressively hawkish jurisdiction, he observed.
“We are not an outlier now,” Jonsson said in an interview in Reykjavik. “I see for the first time that our monetary policy will be in sync with the larger central banks, which I think will make our task easier.”
Iceland has previously struggled with the effects of large inflows from investors seeking a better return offered by its higher interest rate compared to other developed nations. Such pressures piled up in the years before the economy's collapse in 2008, and then forced the imposition of capital controls to prevent mass flight which would have rocked the krona and threatened financial stability.
“It was always problematic in the past that we raised our policy rates and that would create speculation in the currency market,” Jonsson said. “It's always better to be in sync with your main trading partners.”
Last May, policy makers on the north Atlantic island were the first in western Europe to hike rates since the pandemic, and they have since brought borrowing costs to the pre-crisis level of 2.75% in an effort to cool inflation spurred by Europe's fastest-rising house prices.
Read More: Iceland Makes Biggest Rate Hike Since 2008 on Housing Boom
Iceland's economic outlook has deteriorated since the invasion of Ukraine, with higher global commodity prices increasing inflation pressures, the central bank said in its financial stability report Wednesday.
Even so, Jonsson observed that the financial strength of households “has actually never been as good as it is now,” while the banks “are doing quite well” and don't have any “significant” foreign exposure.
He said the main worry now is how the tourism sector -- which is Iceland's largest export accounting for 35% of foreign earnings in 2019 -- will rebound after the pandemic.
“The greatest risk I see now is that higher fuel prices and greater insecurity can lead to that we don't see as many visits.”
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