No mid-winter depression for the ISK
Despite the lack of Central Bank intervention, the fact that the surplus in external trade in goods and services has likely been on the low side in recent months, and the over ISK 10bn in interest payments to non-residents (which can be converted into FX and repatriated) made in December, the ISK has appreciated slightly against the EUR recently. Yesterday for instance the EUR fell by ISK 0.5 and currently costs ISK 179.5. There were no transactions behind this, however, and in all likelihood market makers were adjusting their interbank quotes so that a drop in the EUR against major currencies would not result in a similar ISK drop against currencies other than the euro. A GBP now costs ISK 206 and a USD 127 on the domestic FX market.

Tightened controls make an impact
In our view, ISK stability in the past three months is an indication of how decisive changes made by the Central Bank to currency controls last autumn have proven. They finally closed the route used by many players to trade in ISK on the offshore market. This market practically evaporated following the changes and transactions have been few and far between since then. Although turnover on the interbank FX market has decreased, in our estimation this is not a sign that FX earnings are not being repatriated but that, on the contrary, they are currently sufficient to offset FX outflows for imports and payments on foreign loans.

Whether this balance on the FX market is a temporary or more long-lasting state, is another question. Experience of other countries where such controls have been applied has shown that as time passes, the possibilities of circumventing them increase, sometimes showing incredible ingenuity. On the other hand, the external trade surplus is likely to grow considerably in coming months as the global economic situation improves and increased tourism boosts services trade receipts.

Purchasing power similar to year-end 2002
While wages have increased little, inflation has been galloping, The purchasing power of wages has now dropped by 12.6% from its peak in January 2008. During the past 12M, purchasing power has dropped by 3.6%, and household disposable income can be assumed to have fallen even more sharply, in part due to increasing unemployment and taxes.  

This drop in the real wages of Icelandic wage earners is unparalleled in recent quarters. Not since the early 1990s has there been any similar trend. Furthermore, the drop in purchasing power in a single year has not been this high for at least two decades, or as far back as SI's time series extend. The downward trend has depressed purchasing power to a level equivalent to that of 2002 and a further near-term drop is highly likely, given the labour market situation and the relatively weak negotiating position of most wage earners. Inflation, however, will continue to be substantial in coming months. According to our latest forecast, CPI inflation will increase steadily to peak at 9.4% in March, following which we expect it to decrease once more. Purchasing power is not expected to begin rising once more until the latter half of this year at the earliest.

Payment smoothing index practically unchanged MoM
In tandem with its monthly wage index, SI now publishes a the payment smoothing index, which is used for loan indexation.  The index for February was 96.8, increasing by a mere 0.1 point over January. This month's index is calculated based on the wage index and employment level figures for December. It reflects the 0.3% wage index increase as well as a drop of 0.2 percentage points in the employment level. This index figure for February means that the debt service on loans to which it applies will be similar to that of June 2008. The index dropped to a low of 93 in June last year, after which gradual increases in the wage index and lower unemployment have boosted it somewhat.