By Natsuko Waki
BASEL, Switzerland, Sept 7 (Reuters) - Iceland is likely to come out of a recession in the first half of 2010 and falling inflation and risk aversion might allow the central bank to cut interest rates further, its governor said on Monday.
Speaking to Reuters in the Swiss city of Basel, Iceland's central bank governor Mar Gudmundsson also said the review of International Monetary Fund programme was likely in late September to early October, which is key in boosting confidence as the country is in no desperate need to get funds now.
Iceland slid deeper into recession in the second quarter with the economy shrinking 2 percent from the preceding three month period for an annual contraction of 6.5 percent.
The volcanic island nation's economy was shattered when its outsized banks imploded within the space of a week in October last year, triggering a collapse in the Icelandic crown as well as a tidal wave of job losses and bankruptcies.
Asked when Iceland was likely to come out of recession, Gudmundsson said: "I am expecting that to happen sometime in the first half of 2010 if everything goes well. We have to take into account that although new GDP data shows we are in a recession, it was somewhat better than expected."
Iceland will release new growth forecasts in November.
"There are two possibilities; that the recession gets shallower -- there is some more optimism at the moment -- or recessionary forces come in with some delay," Gudmundsson said on the sidelines of a meeting of central bank governors at the Bank for International Settlements.
"I think the risks are beginning to tilt on the upside," he said of the November forecast.
Gudmundsson, who took office on Aug. 20 after his stint at the BIS as deputy head of the monetary and economic department, said the central bank stands ready to raise interest rates but the cost of borrowing was likely to go down than up.
"If needed, we will raise interest rates, that's always the case, but that's not our baseline scenario," he said.
"We will try to use the room for manoeuvre in the coming months that might be created by stabilisation of the exchange rate, the fall in underlying inflation and some lowering of risk aversion vis a vis Iceland to cut interest rates further ... we will see whether the conditions will be created again to resume lower interest rates."
Iceland's key policy rate stands at 12 percent. Both the International Monetary Fund and the OECD have called on the central bank to commit to tightening monetary policy and to underpin the island's shaky currency.
IMF REVIEW
Iceland's parliament approved late in August a bill to repay Britain and the Netherlands over $5 billion lost in Icelandic deposit accounts, a move Gudmundsson said would allow the delayed review of the IMF programme to take place late in September or October, as well as loans from Nordic countries.
The IMF and other lenders have agreed a $10 billion loan for Iceland, which has a launched a programme to restore confidence in the economy, including recapitalising the banking system and building up foreign exchange reserves.
"The key issue now is not about getting that money. We are not in desperate need to get money at this point in time as we are relatively liquid at the moment in terms of reserves," he said.
"Once the rest of the world sees that we've finalised the IMF programme, we give a signal that we are on the right track."
Central bank governors from key developed and emerging countries are in the BIS for a two-day meeting which ends later on Monday, with many of them in the Group of 20 having just met in London.
Asked about the debate on the world's reserve currencies, Gudmundsson said Special Drawing Rights -- the IMF's internal unit of account -- was unlikely to replace the dollar soon.
"I'm not seeing momentum behind that at the moment. If you look at the history, reserve currencies are linked to powerful countries," he said.
"It's more likely in the long run that when (the Chinese currency) renminbi gradually becomes fully internationalised it might become one of the reserve currencies."
(Editing by Andy Bruce) Keywords: BIS ICELAND
(natsuko.waki@reuters.com, +44 207 542 6721, Reuters Messaging: natsuko.waki.reuters.com@reuters.net)
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