The ISK appreciation since the beginning of July comes on the heels of a four-month period of relative stability starting in early March. From then until end-June, for instance, the EURISK exchange rate fluctuated in the ISK 148-152 range and the USDISK exchange rate between ISK 135 and ISK 142.

Good news about Icelandic companies

At least part of the recent rise in the ISK exchange rate probably stems from expectations of foreign currency inflows in the wake of rumours, followed by confirmed news reports, about global medical device manufacturer Coloplast’s acquisition of Ísafjörður-based growth company Kerecis, which produces medical products from fish skin. The sale price is estimated at the equivalent of ISK 180bn, some two-thirds of which will revert to Kerecis’ domestic owners, who are ultimately expected to exchange at least a portion of their share for Icelandic currency. The acquisition will not be finalised for a few weeks yet, however, and the related FX flows will not take place until then. In other good news, Iceland’s airlines reported favourable passenger numbers in June, and media coverage of a possibly imminent volcanic eruption enhance the likelihood that the peak tourist season will stretch further into the autumn than previously anticipated.

The newly negotiated Coloplast-Kerecis deal is the most recent example of how strongly changes in investment flows to and from Iceland affect the FX market. Last autumn there were two such examples: Síminn’s sale of Míla and Origo’s sale of its holding in Tempo, both to foreign buyers. Net inflows due to registered investment (the grey bars in the chart) totalled roughly ISK 62bn in September and October 2022, with much of that amount generated by these two transactions. Furthermore, there have been sizeable inflows into the FX market in the past year, in connection with Iceland’s inclusion in FTSE Russell’s secondary emerging markets index. Iceland’s transfer to secondary emerging market status was carried out in three stages – in September and December 2022 and March 2023 – and as the chart shows clearly, the latter two stages strongly affected net flows due to new investment.

On the other hand, flows due to trade in goods and services have fluctuated markedly in 2023 to date. For example, preliminary figures recently published by Statistics Iceland (SI) suggest that the June goods account deficit, weighing in at ISK 43bn, was Iceland’s largest since October 2022. On the other hand, new data from the Icelandic Tourist Board show that tourist arrivals in June were on a par with the record numbers from 2018 and that, at the same time, Icelanders scaled down their overseas travel by 16% year-on-year. The deficit on combined goods and services trade was presumably fairly large in both May and June, although the surplus on services has offset the goods account deficit quite strongly in the recent term.

Will this year’s ISK heyday be more muted than last year’s?

It is interesting to compare H1/2023 exchange rate movements with those a year earlier, with an eye to developments in market agents’ forward FX positions.

• In H1/2022, the ISK appreciated by over 5% despite a current account deficit of ISK 64bn, and companies’ and investors’ net forward position with the ISK grew by about ISK 75bn.
• In H1/2023, however, the ISK appreciated by only 3%, even though the current account deficit measured only ISK 10bn in Q1 and was probably somewhat smaller in H1 as a whole than in H1/2022. Data on forward FX positions in June are not yet available, but in the first five months of 2023, firms’ and investors’ net forward position with the ISK only came to ISK 19bn.

It is therefore reasonable to assume that there has been a link between movements in the ISK and developments in forward FX contracts over the past two years, as most of the restrictions on such derivatives trading were lifted only a short time ago, putting an end to more than a decade of tight controls. At the end of May, the commercial banks’ customers held net forward FX positions totalling ISK 175bn, down from the August 2022 peak of ISK 197bn.

To put it succinctly, the FX market beat the Christmas rush in H1/2022, pricing the summer season’s FX inflows into the ISK exchange rate in advance. This year, however, such anticipatory pricing will probably be far less in evidence. As a result, the direct impact tourism-related FX inflows will have on the exchange rate at the time the revenues flow into the country could turn out stronger this year than in 2022. But on the other hand, it is well to remember that the FX market is an unpredictable beast, and other factors such as cross-border securities transactions and investments like the aforementioned corporate acquisitions play an important role as well.

Further ISK appreciation in the offing

Even though the ISK has strengthened in 2023 to date, it is still somewhat weaker than it was a year ago, as well as being below its year-2019 average. Recent exchange rate movements and likely developments in other variables – such as Iceland’s current account balance, international investment position, investment flows, GDP growth relative to trading partner countries, and interest rate differential – strengthen us in our conviction that the ISK has more upside potential in the coming term than it has had in the past two years.

In our recent macroeconomic forecast, we projected that the exchange rate would be about 8% higher in H2/2025 than at the beginning of 2023. If this is borne out, a euro will cost around ISK 142 two years from now, as compared with just under ISK 152 at the turn of this year. The current exchange rate places the ISK around the midpoint in that journey. Nevertheless, the FX market can twist and turn from one period to another, and it is virtually impossible to forecast future exchange rate movements without allowing a wide margin for error.