Long-awaited plan on the table regarding the capital controls
The long wait for the plan about the lifting of the currency controls ended on Friday 25 March when the Central Bank of Iceland published a report on the subject. The report traces in detail the next steps planned by the government and the Central Bank towards lifting the controls. It seems clear that initial measures concerning auctions of offshore ISK will commence soon. However, the report contains no fixed timeframe as the progression of the plan will depend on the success of preceding steps.
According to Arion Research the big news is not the strategy itself but the government´s announcement that the currency controls could remain in place until 2015 and the impact this statement will have on the interest-rate decisions of the Monetary Policy Committee at its coming meetings, as well as general asset prices in the country.
A longer wait for lifting of the controls – will interest rates go lower?
Arion Research speculates that if the Monetary Policy Committee had realized from the start that the wait for the lifting of the controls would be as long as it is turning out to be, the interest rate would have been lowered faster and would even have reached an even lower level today. Reasons to keep lowering interest rates still remain as there is substantial slack in the economy, inflation is low and the ISK exchange rate is relatively stable. However, the Monetary Policy Committee has until now placed great emphasis on maintaining a high interest-rate level, even though conditions in the economy may not have occasioned it. This has been done both to support the short-term ISK exchange rate and to support the pending lifting of the currency controls. Arion Research deems unlikely that a major strategic change is underway at the Committee’s coming interest-rate meetings.
Asset prices may rise
Arion Research believes that an important uncertainty factor has been eliminated. This new strategy will most likely make a significant impact on asset prices in the country as domestic investors have now “finally” received an announcement from the authorities stating that their money cannot leave the country in the next few years. Therefore, only domestic investment options will be available for domestic parties in coming years. Accordingly, funds are likely to flow increasingly from deposits into other asset markets in coming months and even years – especially as deposit rates are historically low at present. Increased demand for other asset classes, i.e. shares, bonds and real property, should therefore encourage a rise in asset prices.