“Market chaos in Iceland,” proclaimed one section of London’s business press last month. With near-morbid fascination, another chronicled the Nordic island lurching “into its third week of crisis”.

But the siren voices started long before that. In February, Fitch downgraded its outlook for Iceland from stable to negative. Not to be outdone, Danske Bank put out an apocalyptic assessment: a 30-40 per cent fall in investment and 5-10 per cent fall in consumption. Adding insult to injury, others bracketed Iceland alongside emerging economies such as Thailand and Turkey.

“There has not been any financial crisis,” says Ingolfur Bender, head of research at Glitnir, formerly Íslandsbanki. “The fall in equity prices was only a correction and was expected. This is far from a financial crisis.”

Mr Bender adds that the Krona’s fall is “in line with what is needed to rebalance the economy. As Moody’s has pointed out, you cannot call Iceland an emerging market. The Icelandic economy has one of the highest GDP per capita in the world and is much more capable of absorbing fluctuations in both its currency and its equity market than Thailand or Turkey.”

Windfall for pension funds

Ironically, the falling Krona has dished up a windfall for pension funds. “For example Frjalsi pension fund has over 30 per cent of its assets in foreign equities, so generally it’s good for pension funds,” says Sigurdur Kristinn Egilsson, executive director for institutional asset management at Kaupthing Bank Asset Management.

The investment chiefs who spoke to nrpn clearly expected the recent developments. “We closed all our contracts for currency overlay in February, because we were expecting the Krona to weaken,” says Mr Egilsson. So too did Gardar Bjarnason, managing director of the Lífeyrissjódur Austurlands. Unsurprisingly, Kristjana Sigurdardóttir, investment manager with the Almenni pension fund, did the same in December. She said: “The krona fell a bit earlier and faster than we expected – we had been thinking in terms of June.”

But what of domestic equities and the rush for the exit as Iceland’s economy falters? True, says Mr Egilsson, it is “quite a tough market“, adding that it is too early to call. While he believes that company valuations are still attractive, he does concede: “The problem is that the momentum is not there right now, although the longer-term outlook is positive with a more volatile short term.”

Gardar Bjarnason agrees: “The Icex 15 today [1 June] is up 3.79 per cent on the year so far without dividends. This is not so bad, although it is disappointing compared with recent years.” He expects the market to remain volatile in coming months.

Nor have pension fund managers abandoned domestic bonds – yet another upside of the crisis that never was, it seems. Mr Egilsson explains that any weakening of the krona increases inflation, which has a knock-on benefit for inflation-linked domestic bonds. “We think those bond are quite attractive to match long-term pension liabilities,” he says, “even though the money market is yielding quite high.”

“I agree with that,” says Ms Sigurdardóttir. “If you look at least a year-and-a-half ahead, I would expect interest rates to fall on those bonds. So the longer term is quite attractive.”

Further rate rises

The three investment managers all back further rate rises, with a fall in consumer spending and a slowing housing market as triggers for the Sedlabanki to halt further upward moves. There are signs already that increases in long-term interest rates have already reduced the demand for housing finance.

“The consumer price index is heavily affected by the krona,” explains Mr Bender, “and so inflation will rise following the krona’s recent slip.” Nonetheless, he expects inflation to fall by the end of next year from 7.6 per cent towards the Sedlabanki target of 2.5 per cent.

Glitnir is forecasting two further interest rate rises: one of 50bp around June or July, and a further rise in September of 25bp, before topping out at 13 per cent. Mr Bender is adamant that rates will not hit the giddy heights of 16 per cent. Yet again, Mr Bjarnason and Ms Sigurdardóttir agree.

So how could a small island provoke such a large misunderstanding? Ms Sigurdardóttir has a diplomatic response: “We need to be more effective in giving out information. I think that is the problem.”

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