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Iceland slashes rates for first time in two years

Iceland has become the latest country to cut interest rates to battle shrinking inflation, but the country's central bank governor said it is not facing the same deflation risks as the euro zone.

The Sedlabanki lowered its key interest rate to 5.75 percent from 6 percent after inflation fell to 1.9 percent in October, and has been below the bank's 2.5 percent target for nine months.

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The Hallsgrimkirkja Church, Reykjavik, Iceland.
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The Hallsgrimkirkja Church, Reykjavik, Iceland.

"There is a very big difference between Iceland and continental Europe in the sense that we are an economy where the slack is more or less disappearing," Gudmundsson told CNBC, adding that wage growth in the country is "very significant".

Iceland was forced to hike rates to 18 percent in 2008 as it battled financial collapse after a spike in inflation and a dramatic fall in the Icelandic krona.

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Gudmundsson said he could not remember a time where there was such "equilibrium" in the Icelandic economy as there is at present.

"We have both internal and external equilibrium. Internally you can see that in the inflation rate and given the fact that unemployment rates are already below 5 percent and hitting the level where we think the equilibrium is," he said.

"Externally we have a current account surplus – the krona has been appreciating. We have been buying a lot of foreign exchange in the market, to the tune of almost 5 percent of GDP – so it is pretty stable," he added.