Iceland in From the Cold

Sweden, Denmark and Norway have tossed Iceland a lifeline. The three Scandinavian countries' central banks have agreed to a €1.5 billion ($2.34 billion) swap facility with their Icelandic counterpart, allowing it to exchange local kronur for euros. In doing so, the three seem to be honoring an informal agreement to backstop Iceland's beleaguered banking system. The krona, which had slumped about 25% against the euro this year, jumped nearly 5% on the news. The new swap facility boosts the central bank's credibility as a lender of last resort for Iceland's commercial banks, which have substantial foreign-currency liabilities. The banks' shares and debt had, until recently, come under sustained speculative attack amid fears they would face credit-crunch-induced liquidity problems. At the very least, the Nordic trio's help buys Iceland some time. Faced with a sliding currency and inflation at 11.8%, the central bank had little option but to push interest rates to a record high of 15.5%. That has been taking its toll on economic activity, raising fears of a nasty recession and adding to pressures on the banks. Although a further half-point hike is still expected this month, the bounce in the krona offers hope that rates will not have to rise much further. Even so, €1.5 billion wouldn't be enough to cover a full-scale run on Icelandic banks by foreign depositors. That would call for another €4 billion, according to Moody's Investors Service. To forestall this worst-case scenario, the banks must continue their painful deleveraging, and the central bank will have to continue administering its bitter monetary medicine to restore confidence in the krona. But at least the Scandinavian lifeline suggests Iceland is no longer being left to face its troubles alone.