GDP growth robust but slightly below forecasts

GDP grew by 4.1% year-on-year in the first six months of 2016. This is noticeably below projections for the year as a whole, as the Central Bank’s (CBI) most recent forecast provides for 4.9% growth, and our own forecast, from June, provides for 5.4%. 

First figures often subject to revision

The figures in question represent Statistics Iceland’s (SI) first figures for Q2/2016 and revised Q1 numbers, and should be interpreted as such. SI has revised its Q1 GDP growth estimate, published in May, from 4.2% to 4.4%, and has revised its year-2014 and -2015 figures as well: 2014 GDP growth has been lowered from 2.0% to 1.9%, and the 2015 growth rate has been raised from 4.0% to 4.2%. 

Strengthens the argument for a policy rate cut

In view of the significant uncertainty surrounding initial GDP figures, it is likely that the CBI’s Monetary Policy Committee (MPC) will not assign great weight to them in its next interest rate decision, scheduled for 5 October. However, these numbers, together with the recent appreciation of the ISK and the decline in inflation expectations, support the rationale for another rate cut at that time. 

Rapid growth in international context

Iceland’s H1 GDP growth rate stands out in international comparison. For instance, the US recorded 1.4% growth over the same period, and GDP growth in the UK and Germany measured 2.1% and 1.8%, respectively. 

Private consumption growth strong, and in line with our forecast

Private consumption grew by 7.7% YoY in H1, well in line with our forecast of 7.8% for the year as a whole. The CBI projects it at 6.7%, which is clearly on the low side, given the H1 figures. Underpinning this strong growth rate is households’ improved financial position – and in particular, the surge in real wages, which grew 10.4% in the first half. 

Rapid investment growth

YoY investment growth was extremely strong in H1, measuring 29.5%, owing mainly to 37.3% growth in business investment. Over the same period, residential investment measured 17.3% and public investment 1.9%. As a result, the investment level in the economy as a whole rose to a post-crisis high of 23% of GDP in the first half of the year. A large share of the growth in investment is related directly or indirectly to tourism; however, industrial development has also been robust so far this year. Increased growth in residential investment is a positive sign, in our view, as new residential properties have been in short supply in the recent term. The low rate of public investment growth reflects continued consolidation by State and municipal authorities, yet in many areas this austerity appears to have reached the limits of good sense, in view of the limited development and maintenance of roads, energy transmission systems, and other infrastructure elements. 

Import growth three times stronger than export growth

The negative contribution from net trade surprised us. Growth in services exports during the first half was below our expectations. Total exports grew 5.3% YoY in H1, including 1.9% growth in goods exports and 9.0% in services exports. In view of the 35% increase in tourist arrivals during the period, this rise in services exports appears rather modest, although it does reflect contractions in various other items, such as intellectual property services (patent applications). Weak growth in goods exports is attributable in large part to the poor capelin season last winter.

Import growth also turned out stronger than we had anticipated. Total imports were up 16.2% in H1, services imports by 12.9% and goods imports by 18.0%. This surge is linked primarily to development in the tourism sector, although strong private consumption-related imports play a role as well, including motor vehicles for private use, semi-durable consumer goods, and imported services such as overseas travel.

On the whole, the contribution from net trade was negative by 4.8% in the first half. Nevertheless, there was a handsome external trade surplus during the period, although it could shrink very quickly if the above-described trend continues.