Macroeconomic forecast: Icelandic economy at a turning point

  • The Icelandic economy is at a turning point. Following a pronounced slack, signs of tension are surfacing in certain parts of the economy. 
  • In historical context, GDP growth has been relatively modest during the current upswing. We expect this to change this year, and we anticipate considerably stronger growth than has been seen thus far in the current upward cycle. 
  • We forecast GDP growth at 4.3% this year and 4.4% in 2016, followed by a marked slowdown in 2017, to 2.5%. 
  • Signs of expansion are starting to show in various parts of the economy – the asset and labour markets, for instance – and we believe a rapid rise in wages and house prices lies ahead. 
  • So far in the current upswing, GDP growth has been driven mainly by exports. For 2015-2017, however, we forecast that domestic demand will grow apace, ultimately playing a much stronger role in GDP during the forecast horizon than it has thus far. 
  • We expect continued export growth centred, as before, in tourism and fishing. We forecast growth in goods and services exports at 7.7% this year, 3.8% next year, and 3.1% in 2017.
  • Even though GDP growth has been relatively modest in recent years, it has been robust enough to create quite a number of jobs, as growth has been concentrated in labour-intensive sectors such as tourism. As a result, unemployment has fallen rather quickly. We expect the jobless rate to fall from 5.0% in 2014 to 3.5% by 2017.
  • During the forecast horizon, we expect labour demand to be met with imported labour to a large degree – much more, in fact, than has been the case thus far in the upward cycle. This will ease the tension in the labour market and contain wage drift to some extent. 
  • Households’ real disposable income has been on the rise, and their equity position has been improving with rising asset prices (including house prices) and declining debt levels. We assume that households’ position will continue to improve in the near future, prompting increased consumption and investment. We project private consumption growth at 4.8% this year, 5.2% next year, and 2.8% in 2017.
  • Firms’ operating conditions are changing markedly at the moment. Domestic demand is growing strongly, although trading partners’ GDP growth is weak. 
  • We expect a continued gap in demand growth in Iceland versus other countries. The real exchange rate of the króna has risen markedly, undermining the competitive position of the firms that compete with foreign companies and posing a threat to the tourism sector, which has grown by leaps and bounds in the recent term. 
  • We expect business investment to gain momentum in the near future. We project growth at 23.9% in 2015 and 18.8% in 2016, followed by a dramatic slowdown to 1.9% in 2017. 
  • We expect inflation to remain close to the Central Bank’s (CBI) inflation target early on and then rise above it as the forecast horizon progresses. The CBI’s Monetary Policy Committee (MPC) will respond to this with further monetary tightening. 
  • The ongoing capital account liberalisation process generates uncertainty about near-term economic developments. Lifting the capital controls is a colossal task, and the impact on monetary variables and the real economy is not entirely foreseeable. It is unclear how liberalisation measures will affect short-term economic stability, although lifting the controls is an extremely positive move and a major factor in the turning point we now see in the domestic economy.
  • There is the risk of overheating during the forecast horizon, with imbalances developing due to surging growth in domestic demand and excessive wage rises. Such a turn of events will ultimately cause a contraction and a correction featuring the all-too-familiar cocktail containing the usual ingredients: currency depreciation, an inflation spurt, elevated unemployment, and erosion of purchasing power. 

You can find our macroeconomic forecast here