Iceland’s Central Bank yesterday hiked its interest rates by a quarter point, taking its benchmark rate to 4.5 per cent, saying inflation continued to climb despite global financial turmoil.

The increase “reflects the fact that the inflation outlook for the coming two years has deteriorated still further since the (Monetary Policy) Committee’s last meeting in June,” the Sedlabanki explained in a statement.

Iceland’s economy, which was among the hardest hit by the 2008-2009 global financial crisis, is continuing to recover and the rekindled crisis elsewhere in the world is no reason to maintain low rates, the bank said.

“The unrest in global financial markets and weaker-than-expected output growth in major industrial countries could in the coming period weigh against the recent strength of domestic demand and have a negative impact on the Icelandic economy over the medium term,” it acknowledged.

It stressed however that “in view of the growing momentum in the domestic economy ... the risk that a modest interest rate hike at the current juncture will derail the economic recovery is low, as the past few months’ steep decline in short-term real interest rates is only reversed to a small degree.”

In fact, Sedlabanki said, it appears that “domestic demand and employment will grow more strongly in 2011 than was assumed in the last forecast.”

Icelandic inflation has risen sharply in the past five months, and in July stood at five percent, which is double the official inflation target of 2.5 per cent and far higher than the 1.8 per cent inflation recorded in January.

“Higher inflation is due in part to a weak krona and rising house and oil prices,” Sedlabanki said, adding that “based on the current exchange rate, the outlook is for inflation to rise well into next year and not return to the inflation target until the latter half of 2013.”