Crisis-hit Iceland's central bank boosted interest rates by a massive 6 percentage points to 18 per cent today, a move that aimed to please the IMF and restore trust in a shattered currency.
Coming just two weeks after borrowing costs had been eased to soften the impact of the country's financial meltdown, the central bank promised to do all it could to make its currency functional again.
The Icelandic crown traded internationally for the first time in a week after the announcement. London dealers said it slumped to 240 per euro compared with Monday's central bank fixing at 152.
The rate rise, which one economist called extreme, meant investors get a much higher return for putting money back into the North Atlantic island's crippled financial system.
"It is of overarching importance to restore stability in the foreign exchange market and support the exchange rate of the crown," central bank Sedlabanki said in a statement.
Sedlabanki Governor David Oddsson, speaking at a news conference, acknowledged that Icelanders would suffer from the higher borrowing costs.
"This rate will obviously be very hard on the public and businesses. It should not come as a surprise given the enormous blow when 85 percent of the banking system collapses," he said.
But the central bank chief, a former prime minister who has recently faced calls to resign from some politicians and the public, said the island would bounce back.
"At the end of all this, my guess is that the biggest surprise will be how fast we were back on our feet given the enormity of the blow."
The central bank said it expected a contraction in demand to push the volcanic island's current account out of deficit which would help lead to appreciation of the crown.
"If forecasts materialise, the policy rate will be reduced in accordance with rapidly subsiding inflation," it added.
Dresdner Kleinwort analyst Jon Harrison said the move would help but more work was needed before people felt comfortable trading the Icelandic crown. "That's started today, but it's still very illiquid," he said.
Two weeks ago, the central bank cut rates by 3.5 points to 12 per cent.
"This has come a bit out of the blue following the latest interest rate cut," BNP Paribas Emerging Markets strategist Elisabeth Gruie said.
Reuters