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If you think the credit crunch is hitting the UK hard, spare a thought for Iceland.
Banks all over the world have spent much of the few years bingeing on cheap money, but Iceland’s taken the whole thing to quite an extreme. Its big players – the likes of Landsbanki and Kaupthing – have been on an extraordinary borrowing spree, sucking in vast quantities of cash to fund lending and acquisitions across Europe and the UK. The result? This tiny country – home to a mere 300,000 people – has somehow created a financial system nine times the size of its GDP.
And a nasty hangover.
Iceland’s economy is in a lot of trouble
Now the cheap credit that fueled the binge has all but disappeared the banks – and the economy – are in trouble. The stock market has tanked, inflation has soared and the Icelandic Krona has fallen 26% against the euro this year. House prices, which had doubled since 2001, are now falling.
According to the Icelandic Central Bank, the economy will contract by 2.5% next year and 1.5% in 2010. “We are still likely to see a fairly sharp slowdown in the Icelandic economy in the coming quarters and the most likely scenario is for negative GDP growth in Iceland in 2008 and 2009”, says Lars Christensen, chief analyst at Danske Bank.
Lucky then that the alka seltzer is on its way.
On Friday, the Nordic central banks extended an emergency loan facility worth €1.5 billion to their island neighbour designed to shore up the krona, give the central bank some credibility as the lender of the last resort to the banks (which have been under huge speculative pressure from many of the world’s big hedge funds) and begin getting the economy out of its sorry mess. “In times of uncertainty and turmoil the central banks have a responsibility to cooperate to attain their overall objectives,” said Swedish Riksbank governor Stefan Ingves. “The swap agreement is aimed at supporting (Iceland) in its task of safeguarding macroeconomic and financial stability.”
Could this spell EU membership for Icelanders?
It’s certainly served to calm nerves – the krona rallied sharply on Friday – but the whole business has also raised a pretty uncomfortable question for the Icelanders. Can they really go it alone in the global market place or should they begin to think the unthinkable and join the euro?
With fishing accounting for over 40% of exports, Iceland has long had reason to very firmly oppose membership of the EU, and by extension the euro in the past. Just ask any fisherman up and down the west coast of Ireland what he thinks of the EU, and the opening of Irish waters to big Spanish tankers. Magnify his fury by 10, and you’ll get a good idea of what Icelanders, a traditionally independent lot, think of the EU.
But with the economy destabilising and the currency all over the place, support is now growing for the idea. A poll published in April by the Icelandic daily Fréttabladid showed that 68% of Icelanders would be willing to open membership negotiations with the EU, against 55% in February. Membership of the EU would mean that the Icelandic central banks would lose the power to set interest rates. But that may well be a perfectly fair price to pay for a more stable currency. “There is growing evidence that the Krona is a source of shocks, rather than a shock absorber” says one professor of economics at Reykjavik University. “The krona is increasing the volatility of the economy.” This is in part because the majority of durable goods, for example cars and washing machines, are imported into Iceland.
So given that the currency has been taking a kicking, Icelanders are now paying much more for the much needed goods they import. Inflation rose to an annualised rate of 11.8% in April, the highest level since September 1990. And over the past three months, consumer prices have risen 6.4%. That’s equivalent to an annual inflation rate of 28%.
Joining the Euro would mean offering up a decent chunk of sovereignty at the the EU’s altar. But then, given that interest rates in Iceland are running at 15.5% and that in the Eurozone they remain at 4%, it might also offer the suffering Icelanders the hair of the dog they really need right now.
Turning to the wider markets…
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The FTSE 100 closed 1.2% higher at 6376.5 on Friday, with the main boost again coming from the mining sector. Vedanta Resources was the biggest mover, rising 8.6% on the back of an upgrade from Citigroup to buy.
On the continent, the German Dax Index increased 69.39 points or 1% to 7225.94. In Paris, the CAC-40 Index closed 64.06 points, or 1.26%, higher at 5142.1.
Wall Street’s Dow Jones Industrial Average was up 1% yesterday to 13,027, as investors wagered that the US economy would avid falling into recession.
Shares of energy companies, including Exxon Mobil, were given a boost by near record high prices for crude oil. The broader S&P 500 Index gained 1.16points to end at 1,426, while the Nasday was down 12.76 points, or 0.5%, at 2,516.
Japan’s benchmark Nikkei closed 0.3% lower overnight, to finish the day at 14,224. In Hong Kong, The Hang Seng Index went up 123.37 points to 25742.23.33.
In London, Brent crude contract for June rose 58 cents to $125.57 while Spot gold hit a high of $913.35 an ounce, its highest since April 23.
Meanwhile on the Forex markets, sterling fell 0.4% to $1.9477 against the dollar and eased 0.1$ to £0.7964 against the euro.
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