UPDATE 1-Iceland's wage dispute threatens economic stability - IMF

May 20, 2015 9:27 AM

(Adds IMF quote)

REYKJAVIK, May 20 (Reuters) - The International Monetary Fund said on Tuesday wage demands by Icelandic trade unions could result in agreements pushing inflation beyond a target and, combined with weakness in Europe, delay a roll-back of capital controls.

The island nation, emerging from years of isolation and hardship following a financial meltdown in 2008, faces crippling strikes by bus drivers, nurses, hotel staff and others at the end of next week if no agreement on wages is struck.

The central bank targets an inflation rate of 2.5 percent and prices have been below that rate for some time. But it said last week it is likely to raise rates in June due to higher inflation expectations as a result of the wage dispute.

There are several disputes between trade unions representing a host of industries and employers including the state; but in general double-digit wage rises are demanded, while unions also seek an increase in the minimum wage by a third.

"Such wage hikes will likely push inflation significantly above the Central Bank of Iceland's 2.5 percent inflation target and will generate budget pressures, dampen confidence, and reduce competitiveness," the IMF wrote in a report.

"Disruptions could be worsened if other downside risks materialize, such as from the euro area. Such developments could delay capital account liberalization for the real economy, with inhibiting effects for savers, investors, and growth," it said.

Iceland's 300,000 population has suffered lower living standards since the collapse of its three main banks under debilitating debt which led to a far weaker crown currency as well as the imposition of capital controls.

But, after posting solid economic growth last year and coming close to winding down the bankruptcies with foreign creditors, the central bank wants to start the process of lifting the controls at some point this year. (Reporting by Ragnhildur Sigurdardottir, writing by Sabina Zawadzki in Copenhagen; editing by Ralph Boulton)