Iceland lifts rates to 18% from 12%

Iceland's central bank hiked interest rates on Tuesday from 12 per cent to 18 per cent in one of the first indications of the dramatic impact a $6bn International Monetary Fund-led rescue package will have on the country's economic policy making.

The move is an attempt to support the Icelandic krona, which has lost 70 per cent of its value during the crisis before trading in the currency was halted. It is due to re-float within a matter of weeks.

The Icelandic economy is expected to contract by up to 10 per cent as a result of the crisis, unemployment will spike to around 8 per cent or higher and inflation could hit 20 per cent or more, according to economists.

The huge interest rate hike came as Iceland continues to try and rally international support for multi-billion dollar loans to help bolster its foreign exchange reserves, a move that should also help support its currency once its resume trading.

The country has applied for a $2bn loan from the IMF and is also expected to agree additional funding worth up to $4bn from its Nordic neighbours and other central banks.

Geir Haarde, prime minister, was quoted as saying Tuesday that he had sent an application to the US Federal Reserve and the European Central Bank for assistance. Iceland is also expected to receive financial support from the Bank of Japan, and may also make use of a loan from Russia, Mr Haarde has said.

Although the IMF-led rescue package represents a breakthrough for Iceland in its bid to stabilise its economy, it has also been forced to agree to a number of conditions set down by the organisation as part of the loan agreement.

These conditions have focused on three areas: the banking sector, fiscal policy and monetary policy, and the exchange rate. The IMF sought assurances on the restructuring of the banking sector and has demanded a review of Iceland's banking legislation to ensure it conforms with international best practice.

The IMF has also asked the government to compile a credible plan for fiscal tightening in response to government debt levels, which are expected to rise to well over 100 per cent of gross domestic product.

The Icelandic krona is expected to be floated again as soon as practical, possibly within the next two weeks once the IMF's board has approved the $2bn loan. Once approval has been secured, Iceland will be able to draw down an immediate $830m.

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