Standard & Poor’s cut its outlook for Iceland to “negative” from “stable” yesterday, as the rating agency said that the North Atlantic nation had failed to address its economic imbalances and was facing the growing risk of a hard landing.

The Icelandic krona fell against the dollar and the euro and the cost of insuring the country’s debt against default rose after S&P pointed to the worsening of the country’s current account deficit.

S&P said that brisk consumer spending and slower-than-expected exports growth meant that Iceland’s current account deficit would not narrow as fast as had been thought. In addition, fiscal policy was too loose.

Iceland’s economy has grown rapidly in recent years thanks to deregulation and a consumer boom.

The country’s banks have made a series of highly leveraged overseas acquisitions in recent years.

Icelandic firms, such as Baugur and Kaupthing, have bought up stakes in a string of British retailers, from Oasis and Karen Millen to Moss Bros.

However, the country is struggling to rein in growth and is suffering from inflation at 5.2 per cent, interest rates at a record 13.75 per cent and a current account deficit that reached 51 billion kronur (£416 million) in the second quarter, equivalent to around 17 per cent of GDP.

The report said that property inflation was being fuelled by competition between the state-owned Housing Financing Fund (HFF) and commercial banks.

S&P said: “The negative outlook reflects the increased risk of a hard landing for the Icelandic economy.

“The economic slowdown currently under way will facilitate an unwinding of macroeconomic imbalances, but the process is likely to be impeded by the planned rapid acceleration in public expenditure, as well as sustained failure to reform the HFF.”

Growth could be hit by shifts in exchange rates, the housing market or credit conditions, it added.

In September S&P said that Latvia and Iceland were the European economies most at risk from a worsening of the global credit squeeze. It said that if the global carry trade was to unwind, Iceland could be forced to raise interest rates, making recession a possibility.

This month Iceland’s central bank said that the outlook for inflation had worsened. It will hold an extra rate-setting meeting in December.

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