REYKJAVIK (AFP) - Iceland's central bank on Wednesday said it cut its key interest rate by 0.25 percentage points to 4.25 percent because of dwindling inflation and a favourable exchange rate.

“The economic recovery will be somewhat stronger this year than was forecast in November,” the bank said. “While economic fundamentals and the capital controls continue to support the krona, the exchange rate has depreciated by 4.5 percent in trade-weighted terms since the December meeting.”

“With the prospect that inflation will remain near target and with interest rates at a historically low level, the direction of future policy moves becomes more uncertain,” the bank added.

Since Iceland's massive financial and economic meltdown in late 2008, when its main banks collapsed and its key interest rate soared as high as 18 percent, the central bank has progressively reduced borrowing costs in an attempt to get the country's economy moving again.

In January 2010, the key interest rate still stood at 10 percent.