Economic developments: The Icelandic Central Bank raises interest rates, Lagarde warns of Europe's challenges, and high inflation in Britain

On Wednesday, the Icelandic Central Bank raised its key interest rate by 25 basis points to 8 percent; Pointing to the continued rise in inflation and its expectations, at a time when the economy is facing continuing price pressures.

The central bank, which targets annual inflation at 2.5 percent, said: “Inflation expectations remain very high, as does core inflation.”

He added that inflation is expected to decline quickly in 2027, but pointed out that a great state of uncertainty remains. Especially regarding developments in the global economy and the local labor market.

4 members of the Monetary Policy Committee voted in favor of raising the interest rate, while one member supported keeping it unchanged.

Inflation has remained persistently high in recent years in Iceland, a small island nation that is highly dependent on imports. Consumer prices in July rose 5.3 percent year-on-year, a level that more than doubled the central bank's target.

European Central Bank President Christine Lagarde has warned that Europe cannot afford to be left behind as artificial intelligence transforms the global economy, calling on the continent to remove barriers to business expansion and technology development, so it can transform its single market into a more sustainable engine of growth.

Lagarde said - during her participation in a discussion on the prospects for the global economy at the World Economic Forum in Geneva - that there are encouraging indicators of an increase in European companies’ investments in artificial intelligence, noting that euro zone companies expect to allocate about 9 percent of their total investments to artificial intelligence this year. But she warned that Europe had already largely missed out on the gains of the first digital revolution, when a large share of commercial revenues from the spread of information and communications technologies went to other regions of the world.

She said: “We cannot afford to repeat this experience with artificial intelligence, the second digital revolution.”

Lagarde painted a broader picture of the challenges facing the European economy, saying that the growth model that Europe has relied on since World War II was based on three interconnected pillars: the expansion of global trade, the strength of medium-tech manufacturing supported by cheap energy, and a stable, rules-based global order supported by the American security umbrella.

She added that the three pillars are weakening as the global economic and geopolitical environment changes, and that the post-war European growth model is unlikely to return to the form it was previously.

She explained that Europe has benefited greatly from globalization and has become one of the most open economies to trade in the world, but the continued expansion of trade is no longer guaranteed, noting that more than 2,500 new trade restrictions were implemented globally during the past year alone.

Lagarde said that Europe's strength in medium-tech industries is facing increasing pressure, with China rising on the value-added ladder. She pointed out that China has become a direct competitor to the Eurozone in about 40 percent of the sectors in which Europe has a comparative advantage, compared to about 25 percent in the early 2000s.

At the same time, the advantage of cheap energy on which European industry relied, including Russian gas, has declined.

She said that the electricity prices paid by energy-intensive industries in the European Union last year were, on average, more than double their levels in the United States, and about 50 percent higher than in China.

Lagarde pointed out that the third pillar, which is a stable, rules-based global order, is also under pressure.

She said that geopolitical tensions have made choke points and dependence on supply chains more apparent, at a time when Europe faces increasing security threats on its borders.

She added that concerns related to economic flexibility have become directly involved in companies' decisions. Especially when economic dependence can be used as a weapon, or when confidence in the deterrence capacity weakens.

Despite these challenges, Lagarde said that Europe still has great strengths, most notably the single market, which includes 27 countries and 450 million consumers, and is the largest market among advanced economies.

She pointed out that the euro zone economy grew by 1.5 percent last year, driven entirely by domestic demand, while it continued to grow during 2026 despite the energy shock.

The challenge now is to transform this local resilience into a more sustainable source of long-term growth, she said.

Lagarde believes that Europe has a strong base that enables it to compete in new technology. It includes about 15 percent of the world's researchers, even though the population of the European Union represents about 6 percent of the world's population, and it also produces nearly a fifth of the most cited scientific research globally. But she warned that the problem lies in converting this knowledge into commercial success, and ensuring the spread of new technology throughout various sectors of the economy.

She said that the fragmentation of the single market represents one of the most important obstacles. European companies still compete largely within their national borders, limiting the competitive pressures needed to accelerate AI adoption.

The second obstacle - according to Lagarde - is the fragmentation of European capital markets. She said that innovative European companies can usually finance their early stages of growth, but a gap begins to appear as they scale.

It quoted the European Investment Bank as saying that fast-growing emerging companies in the European Union and their counterparts in the San Francisco area raise similar amounts during the first five years, but by the tenth year European companies have raised about 50 percent less.

About 12 percent of fast-growing European startups have moved outside the European Union, especially to the United States.

Inflation rose in Britain last July to its highest level since March, driven by an increase in household energy bills, after the energy price ceiling set by the energy sector regulator Ofgem was raised by 13 percent.

Data from the Office of National Statistics showed, on Wednesday, that the annual consumer price inflation rate rose to 2.9 percent in July, from its lowest level in 15 months of 2.6 percent in June.

The reading was broadly in line with the expectations of economists polled by Reuters, while the Bank of England had expected a smaller rise to 2.8 percent in its forecasts issued at the end of last month.

Core inflation, which excludes more volatile energy and food prices, rose to 2.6 percent, above economists' average expectations of 2.5 percent.

British Finance Minister John Healy said, commenting on the data: “The repercussions of inflation resulting from the war in Iran are still affecting prices here at home, but the British economy is resilient.”

The pound sterling maintained its gains against the dollar in early trading, rising 0.14 percent to $1.3552, resuming its rise after being under pressure the previous day following the release of relatively weak jobs data.

Ruth Gregory, deputy chief economist in the United Kingdom at Capital Economics, said that domestically produced inflation is still under control, expecting it to decline to 2 percent, which is the target level of the Bank of England, by the end of next year, if energy prices do not rise significantly from their current levels.

Traders expect the Bank of England to implement at least one interest rate cut this year, according to data collected by LSEG.

But the majority of economists polled by Reuters expect the central bank to keep the interest rate unchanged at 3.75 percent.