Icelandic central bank raises key interest rate

Iceland's central bank unexpectedly raised the benchmark interest rate to 18 percent, the highest in at least seven years, after the island reached an aid agreement with the International Monetary Fund.

Policymakers raised the key rate by 6 percentage points, the Reykjavik-based bank said in a statement on its Web site yesterday, taking the rate to the highest since the bank began targeting inflation in 2001. The central bank is raising rates as Iceland, the first western nation to seek aid from the IMF since the United Kingdom in 1976, faces a prolonged contraction, coupled with possible hyperinflation and rising joblessness. The economy will shrink as much as 10 percent next year, the IMF forecasts. Iceland will receive about $2.1 billion in aid from the Washington-based fund, according to a deal struck on Oct 24.

This is "a first step toward opening their currency market and is probably one of the conditions attached to the agreement struck with the IMF", said Bjarke Roed-Frederiksen, a Copenhagen-based economist at Nordea Bank AB, the biggest Nordic lender.