Then, I will outline the Central Bank’s inflation forecasts presented in the Inflation Report, which will be posted on our website shortly. Although the recovery in global economic activity is expected to be slow and gradual, the perception that the worst part of the crisis is over has continued to support optimism across financial markets and increased the appetite for risk during the third quarter. Parallel to the recovery in global risk perceptions, the risk premia of emerging markets fell rapidly and reached almost pre-crisis levels (Figure 20). In this period, the perception was that many emerging markets, which had been considered in the pre-crisis period as ‘highly risky’, were not as risky as envisaged. Favorable statements of credit rating agencies regarding the sovereign rating of Turkey – one of the leading countries among these emerging markets – alongside the relatively lower level of Turkey’s risk premium compared to other emerging  8  BIS Review 143/2009  markets – as was the case throughout the crisis – have confirmed the decline in Turkey’s relative riskiness (Figure 20).
Negative coverage of the banks and Icelandic economy went hand in hand at this time, both temporarily eroding international investor confidence. The reputation of Iceland’s economy and banks was tarnished. From an Icelandic perspective, the first months of 2006 were therefore characterised by a currency depreciation, falling equity prices and international discussion about the viability of Icelandic banks and macroeconomic imbalances in Iceland. A massive economic downswing was even predicted, possibly comparable to the southeast Asia crisis of the late 1990s. This was a development we had not particularly expected or prepared for. Interestingly, not only did Iceland feel the tangible effects of changes in sentiment in global financial markets – the turbulence in Iceland also reverberated through a number of distant countries with which we have no business contact. This shows that Iceland had become integrated into the global financial market. It was obvious that the Icelandic banks and authorities faced a major challenge that called for a serious response. The banks responded with greatly increased communication about their activities, financial position and other targets of criticism. They made various reforms, answered other points in detail, slowed down their expansion, tapped new credit markets and, last but not least, refuted predictions that the turnaround in external conditions, weaker króna, lower Icelandic equity prices, higher finance costs, etc. would have to dent their profitability severely.