Currency controls fuel next housing bubble in Iceland

Iceland’s crisis-management policies are creating the island’s next property bubble less than four years after its banking meltdown threw the economy into recession.

Prices for new homes touched a record last quarter, having surged 40.1% since the final three months of 2010, according the national registry. Average house prices have risen 11.3% since the market bottomed at the end of 2009.

Currency controls imposed in 2008 and designed to protect the country from a mass capital exodus are channelling funds into a market that is showing symptoms of overheating.

About €6.2bn (1,000bn Icelandic krona) is held by offshore investors unable to get their money out of the country, according to Arion Bank economist Thorbjorn Sveinsson. As the government signals restrictions will remain until at least 2015, funds are flowing into one of the few longer-term investment options: property.

“If the development continues without interference, this will lead to a property bubble within the next two years,” said Asgeir Jonsson, an economist at asset manager Gamma. “There’s a greater risk of an asset bubble being created in an economy that is closed off behind capital controls.”

Iceland, whose €70bn banking default in 2008 pushed the economy into recession until 2010, is outgrowing Europe and the US. Its GDP will expand 3% this year and 3.9% in 2013, according to Arion.

Iceland’s rebound is being driven by household spending. The central bank has raised the benchmark lending rate to 5.5% as consumer prices grew an annual 6.4% in April.

“Last year, investors finally realised that the capital controls aren’t going anywhere any time soon,” Mr Jonsson said. “That has led to a change in investors’ perspective, and they’re now moving in greater numbers into longer assets and snapping up properties.”

An average apartment cost about 28m krona (€173,000) in May. The average Icelandic household earned about 4.4m krona in 2011.

“The exorbitant prices in the housing market, so early after the collapse of the Icelandic economy, are quite shocking,” said Finnur Eiriksson, a computer scientist in Reykjavik. “For anyone that has been shopping around, the drop in property prices after 2008 hasn’t been significant enough.”

The nation of 320,000 people stunned the world with its 2008 banking crash. Its rapid resurrection won accolades from economists including Nobel laureate Paul Krugman, who praised an approach which he termed “bankrupting yourself to recovery,”.



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