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Krona rally returns after end of Iceland’s capital controls

Well that didn’t last long.

Two months after Iceland removed its capital controls, hopes that the shift would ease pressure on the country’s currency appear to have been in vain.

The Icelandic government finally lifted crisis-era capital controls in March, marking a return to financial normality seven years after the implosion of the country’s three largest banks sent the krona into freefall.

By allowing domestic pension funds to diversify their assets and invest abroad, some hoped that the move would alleviate some of the pressure on the krona, which had been the best-performing currency of any developed nation in the previous 12 months, pushing inflation below the Central Bank of Iceland’s target.

Things started well, with the krona immediately experiencing its biggest one-day drop since the financial crisis and proceeding to weaken more than 6 per cent against the euro in March.

However, the currency has since recovered all of its losses, and, at 113.10 per euro, is currently at its strongest level since March 7, the week before the controls were lifted.

Although the lifting of controls has freed up Icelandic funds to invest overseas, it has also made Icelandic assets more attractive for foreign groups looking to share in the island’s recovery. Less than a week after controls were lifted, Goldman Sachs joined a trio of hedge funds in acquiring almost a third of Arion Bank, a successor to one of the banks that failed during the crisis. Moreover, the CBI’s key interest rate currently stands at 5 per cent, offering a very attractive yield at a time when much of Europe still has negative rates.

Against the dollar, the currency move has been even more extreme. Helped along by the buck’s broader decline in recent weeks, the krona has hit its strongest level since the banks collapsed in October 2008.

Benedikt Johannesson, Iceland’s finance minister, has said that in the long-term it is untenable for the small country to maintain its own free-floating currency. However, the prime minister (who happens to be Mr Johannesson’s cousin) is not sure, has stressed the benefits of a free float. A group of economists commissioned by the government is expected to report on the best steps to stabilise the currency later this year.