Iceland's recovery still on track but slowing

STOCKHOLM Thu Mar 8, 2012 5:37pm IST

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STOCKHOLM (Reuters) - Iceland's economic growth more than halved in the final quarter of 2011 to 1.9 percent on a quarterly basis, underlining challenges to what had been a surprisingly strong recovery from its 2008/09 economic meltdown, data showed on Thursday.

While the 2 percent quarter-on-quarter expansion was much stronger than growth across most of the rest of Europe and means Iceland should avoid another recession, it was down from a revised 4.4 percent expansion in the third quarter as exports slowed sharply.

That suggests the economy is facing headwinds after rebounding from a crash in 2009/10 when the country's main commercial banks collapsed under a mountain of debt, forcing Iceland to secure an IMF bailout and impose capital controls to support the crown .

Export growth eased to just 0.7 percent in the fourth quarter on a quarterly basis, from 7.7 percent in the previous quarter, though private consumption edged up, to 1.6 pct from 0.2 percent.

"Is it surprising (GDP) growth is slowing down? No, it is not, not given what is happening in the world," said Danske Bank senior analyst Lars Christensen.

"I am not concerned they are going to slump from here."

Year-on-year, output rose 2.7 percent in the final three months of 2011 after 3.8 percent growth in the third quarter.

Iceland recovered its investment grade rating from agency Fitch this month but currency controls remain a problem.

The central bank said on Tuesday that a recent slight loosening of the capital controls had resulted in unusually large outflows of foreign currency.

Since the crash there has been much political discussion in Iceland over whether to stick with the crown or adopt another currency to help bring stability to the economy.

Having already begun talks on joining the European Union, the country had been widely expected to adopt the euro, although opposition to EU accession is growing.

INFLATION PRESSURE

Iceland's economy slid 6.8 percent in 2009 after its banks collapsed and shrank a further 4 percent the following year. In 2011, it grew 3.1 percent.

In June last year, it was able to return to the international bond market for the first time since the crisis.

Growth this year is expected to be around 2.5 percent, according to the International Monetary Fund, which helped bail out Iceland after its 2008 crash.

"Two-and-a-half percent is still decent," said Danske's Christensen.

A volatile currency, which has weakened since the start of this year, is adding to inflation pressure, which has been above the central bank's 2.5 percent target for the past 12 months.

The central bank raised rates twice last year and warned at its most recent meeting in February that it stood ready to tighten policy again.

The IMF also warned recently that interest rates would have to rise from 4.75 percent to contain inflation, adding that capital controls may need to stay in place longer than previously planned.

That would further hamper Iceland's recovery. Unemployment remains relatively high, at 6 percent at the end of 2011, versus about 2 percent before the crisis struck.

"If you want to build ... a normally functioning economy, you have to get rid of those restrictions," Danske's Christensen said, adding that he saw no need for rate hikes as there was little demand pressure.

(Editing by Susan Fenton)

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