according to the forecast, inflation should be close to target around the middle of next year. whether that happens earlier or later depends primarily on developments in the exchange rate. it was therefore a disappointment to see how much prices rose in february, raising twelve - month inflation once again. it is always imprudent to read too much into individual measurements, and it has yet to come to light how much of that increase was based on temporary factors. furthermore, the exchange rate has risen more than 5 % since the beginning of the year, which could affect the next measurements. nonetheless, this inflation measurement gives good reason for caution, and if the role of temporary factors proves smaller than might appear at present and inflation declines to the target more slowly than previously forecast, it will be necessary, other things being equal, to withdraw monetary accommodation sooner than would otherwise be required. the central bank ’ s interest rates have been unchanged since november 2012, when they were raised by 0. 25 percentage points. in its november statement, the monetary policy committee implied that the bank ’ s nominal rates could remain unchanged in coming months if developments were in line with the forecast and no additional pay rises were negotiated during the wage settlement review early this year. this has been borne out so far, and the committee kept rates unchanged at its december, february, and march meetings. at present, the central bank ’ s effective real interest rate is positive by just under 1 %. although it has risen by nearly 2 percentage points in the past year, it is still below the equilibrium real rate once the economy has recovered and the slack has disappeared. if the economic recovery maintains its pace in coming months, it will therefore be necessary to withdraw the accommodative monetary stance still further. the pace at which this happens depends on economic developments, and the degree to which this normalisation takes place through higher nominal central bank rates will depend on future developments in inflation. towards the end of last year and in the past several weeks, the central bank has sold foreign currency in the interbank market. the bank also announced that it had temporarily suspended its programme of weekly foreign currency purchases. these measures were approved at an extraordinary meeting of the monetary policy committee in early january. the intervention measures amount to 7 b. kr., including 4 b. kr. this year. in comparison, the bank was a net buyer of foreign currency in the amount of 60 b. kr. in 2010 – 2012, and those foreign currency purchases were made

limits, but their share in total exports is still small. the next crossroads stems from the vast improvement in iceland ’ s foreign liquidity and the build - up of the foreign exchange reserves. as of the end of february, the reserves totalled 719 b. kr., or 46 % of gdp. iceland ’ s foreign reserves have never been larger as a share of gdp, not even at the end of world war ii. increased reserves, enhanced stability, progress in the implementation of the plan to achieve a fiscal surplus in coming years, and buybacks of treasury foreign debt in the secondary market have silenced the voices that prognosticated sovereign default. these factors contribute to the assessment that it is now considered safe to start removing capital controls on outflows and that the conditions have improved markedly for treasury foreign borrowing, which could pave the way for other domestic entities. the icesave referendum taking place this coming weekend could, of course, affect these prospects. if the “ yes ” vote carries the day, plans for capital account liberalisation and treasury borrowing will proceed as currently planned. if the icesave agreement is rejected, however, there are indications that two major credit rating agencies will decide to downgrade bis central bankers ’ speeches iceland ’ s sovereign debt to sub - investment grade. this would impede foreign borrowing and delay capital account liberalisation, although it is not clear how strong or persistent these effects would be. the financial system is at a crossroads as well. the first phase of financial system reconstruction is largely complete. iceland ’ s banks have defined balance sheets, private sector debt restructuring is underway, and changes have been made in order to address the most obvious flaws in the regulatory framework governing domestic financial institutions. a number of tasks remain unfinished, however, as regards establishing a stable, effective financial system. it is not yet possible to state with certainty that financial institutions could fund themselves without the support of capital controls and the declaration of a blanket deposit guarantee. in this context, it is critical to enhance the functioning of the financial markets, which are important for trading, funding, and risk diversification – particularly the foreign exchange and equity markets. it is also essential that financial institutions and other entities re - establish their access to foreign credit markets. a further task is to formulate policy regarding the nature, size, and international relations of the icelandic financial system. it is no less important to formulate policy concerning the tools and institutional structure for financial stability : the financial crisis has