Iceland needs to raise interest rates to combat inflation and should target debt-relief measures for households in financial distress, the Organization for Economic Cooperation and Development said.
Iceland should “continue to tighten monetary policy as activity recovers to reduce inflation to the target rate and anchor inflation expectations,” the Paris-based OECD said in an economic survey of the island released today. Further debt writedowns should be aimed at “households in financial stress to reduce default risk most effectively.”
Iceland’s inflation rate exceeds the central bank’s 2.5 percent target, fueled by a weak krona. Annual inflation was 3.3 percent in May, slowing from 5.4 percent a year earlier. Iceland imposed capital restrictions after the failure of its biggest banks in 2008. The government sought to halt a krona sell-off when the currency lost as much as 80 percent against the euro on the offshore market. Even so, the controls have failed to prevent a slide of about 8 percent in the krona against the euro from a high at the end of January.
Icelandic lenders have forgiven household debt equal to about 12 percent of gross domestic product since the bank failure. Through the end of 2012, the island’s lenders had written off 212.2 billion kronur ($1.7 billion), according to the Icelandic Financial Services Association. The group estimates a further 35.3 billion kronur will be forgiven this year.
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