##ncies, as recent examples have shown. the krona is presently 15 % weaker than in the closing weeks of last year. of course this is a fairly sharp change over a short time. but the fact remains that the exchange rate index is currently hovering around the average for the period 2001 - 2005. i point this out because some of those who developed a sudden interest in the icelandic economy overlooked the background to the depreciation of the krona so far this year which is important to keep in mind. the central bank ’ s main objective is to contribute to a twelve - month rate of inflation as close as possible to 2½ %. for various reasons this target has proved difficult to attain recently. probably the most important factor has been the structural changes in the mortgage loan market in 2004, with the easing of the housing financing fund ’ s lending rules and the subsequent entry of commercial banks and savings banks into the market. these changes caused real estate prices and private consumption to surge. in the recent term, house price inflation has accounted for the lion ’ s share of the increase in the cpi. the central bank had hoped that house price inflation would slow down or stop before the krona began to weaken. if housing prices had risen by little or nothing, they could have offset the effects of the eventual depreciation. regrettably the outcome was as i described, i. e. the krona fell sooner and faster than had been expected, and before real estate price inflation began to come down to a sufficient degree. inflation will therefore clearly remain some way above target over the months to come. a necessary economic adjustment lies ahead. one of the chief characteristics of the icelandic economy is its high degree of flexibility and adaptability. this has often been demonstrated over the years and is one factor that international rating agencies repeatedly underline in their reports on iceland ’ s sovereign ratings. thus there is every reason to expect that macroeconomic imbalances will ease quickly in the near term. in this process, investment is bound to contract sharply when the aluminium sector projects come to an end and private consumption will shrink as well, to leave very low or even zero gdp growth in 2007. such a scenario is necessary to achieve acceptable internal and external balance. after the robust growth episode of recent years, it is time to slow down for a while. experience shows that the exchange rate plays a key role in macroeconomic adjustment. given the precedents, a depreciation will smooth out imbalances fairly swiftly.

ministries with which the bank works most closely – in particular, the ministry of finance and economic affairs, which now is responsible within the ministries for the affairs of the central bank. in this context, i wish to thank the two ministers who have led the ministry of finance and economic affairs since this arrangement was introduced. i would also like to thank the parliament of iceland, particularly the economics and commerce committee, for their cooperation during the year. thanks are due as well to the financial supervisory authority for growing collaborative relationship. i thank the outgoing supervisory council for good cooperation. and last, but certainly not least, i would like to thank the staff of the central bank for their hard work and excellent contribution during the year. bis central bankers ’ speeches