Landsbanki Research has said that the continued strengthening of the Icelandic krona, which began with the construction of large-scale industrial projects in 2002, is over. From now on, the krona will gradually weaken.
The huge difference in interest between Iceland and its main trading countries have played a large part in strengthening the krona and keeping it high. The issue of bonds in Icelandic krona overseas is now over ISK 150 billion (US 2.4 billion). Up till now the issue has strengthened the exchange rate and pushed interest decreases. But a considerable number of these bonds mature in September or before, and this will probably force the exchange rate down.
The bank predicts that the trade deficit will be 15% in January 2006. This is a massive deficit that large-scale industrial projects and tremendous private consumption of all sorts has created. Optimism, increased purchasing power, sufficient employment, and favorable housing and other loans have encouraged and maintained consumption. This may increase leverage of the home without increasing the debt burden of loans to any significant degree.
The Analyst Department expects that the Central Bank of Iceland will increase interest rates by 0.25% on each the next three days when interest rates rise: at the end of January, the end of March and the middle of May. If this happens, policy rates will be 11.25% by late spring. However, inflation will continue to be well above the goal of the Central Bank of 2.5%, or at 4% or above until at least mid-summer, before decreasing towards the end of the year.