above the prevailing level in other industrialised countries. in a climate of excess liquidity, historically very low global interest rates and risk - seeking investors, it was only to be expected that investors would notice high - yield instruments in icelandic currency. so no one need have been surprised when the first krona - denominated bonds, known as glacier bonds, were issued in the global market in autumn 2005. issuance was driven by carry trades and global investors ’ search for yields, and partly also by the demand for credit in iceland. despite the great deal of information that is generally available about the economic position and outlook in iceland, and the central bank ’ s very candid appraisal of the exchange rate of the krona in autumn 2005, which i have already described, it seems certain that many investors in glacier bonds, at least during the first months of issuance, had not examined the potential risks properly. investors probably bore in mind iceland ’ s high sovereign rating in their decisions but ignored the risk that the krona might still depreciate, given that the real exchange rate was far above the average for the past quarter - century. at least, this risk was obscured by high interest rates. in the turmoil in early 2006, various investors in glacier bonds, institutional investors in particular, are likely to have closed their positions from autumn 2005 and thereby contributed to the depreciation of the krona, losing sizeable funds in the process. glacier bond issuance has gone in waves, largely in line with global movements in carry trades. it was substantial in autumn 2005, dropped sharply in the first half of 2006, then picked up in the autumn and has been fairly large since then. currently the outstanding amount of glacier bonds is equivalent to roughly a third of gdp. the first issues matured in autumn 2006 and several others since then. maturities have not sent tremors through the fx market, even when relatively large issues mature. this is consistent with the experience of countries such as new zealand, where “ kiwi bonds ” denominated in the new zealand dollar have been issued for much longer than glacier bonds. large issues of glacier bonds will mature shortly and it cannot be ruled out that they will cause some unease. there have been a number of effects from the glacier bond issuance. derivatives in connection with these issues have dampened the impact of central bank policy rate changes on other interest rates in domestic financial markets. glacier bonds thereby delayed the transmission of monetary policy measures, divert

shifted and the icelandic currency, the krona, began to depreciate. over the year and a half from spring 2000, the krona depreciated by one - third. the central bank raised its policy rate, although its hands were partly tied by the fixed exchange rate regime. it also repeatedly intervened in fx market trading to defend the krona, significantly eroding its net foreign reserves. to cut a long story short, it was decided to introduce a new monetary framework in march 2001. an inflation target was set for the central bank and the krona was floated. by that time it had already fallen to the lower tolerance limit. the krona then depreciated further, driving up inflation which rose beyond 9 % in january 2002. a rapid reduction in inflation followed, the target was attained by the end of the year and the policy interest rate was quickly lowered. inflation remained below or close to target until the middle of 2004. later that year, major investments were decided in the aluminium and power sectors. shortly afterwards, sweeping structural changes in the housing mortgage market caused a surge in bank lending and domestic demand. the current account also deteriorated significantly. in the face of mounting inflationary pressures, the central bank steadily raised its policy rate ( undiscounted yield ) from 5. 3 % in spring 2004 to 14. 25 % at the end of last year, where it still remains. higher interest rates caused the krona to appreciate and it ended up at a historical high, especially in late 2005. following earlier comments to that effect in its monetary bulletin in december 2005, the central bank pointed out that the krona was at its strongest in real terms since 1988. one assumption in the inflation report presented then was that the exchange rate would remain unchanged over the forecast horizon. the bank described this assumption as unlikely to hold. in historical terms, the real exchange rate has only remained so high for short periods. the central bank thus openly stated its view that the exchange rate was unsustainably high and must weaken. however, the timing and pace of the depreciation was unknown. following the privatisation programme that was completed in 2003, the icelandic banks expanded very rapidly. privatisation unleashed an enterprising spirit and the resolve and ambition to enter new territory. the banks sharply stepped up their activities outside iceland by acquiring foreign financial companies and establishing branches. these radical changes are reflected in the growth of the three largest icelandic banks ’ total assets from