Statistics Iceland’s (SI) newly published national accounts data, which extend through Q3/2024, show that the economy continues to adjust after the upswing of the past few years. GDP shrank in real terms by 0.5% year-on-year in Q3, after an abrupt contraction in Q1 followed by marginal growth in Q2. The contraction is due to a negative contribution from net trade. For example, national expenditure – which broadly reflects domestic demand – grew by 0.8% YoY in real terms. Exports, on the other hand, contracted by 2.2% YoY, while imports contracted by 0.7% over the same period.
Economy in adjustment as GDP contracts in Q3
GDP contracted by 0.5% in Q3, in a clear indication that the economy is readjusting after the recent boom. Unfavourable developments in services trade weigh heavily in the modest contraction year-to-date, although a downturn in private consumption per capita is a factor as well. The outlook is for a moderate contraction in 2024 as a whole, followed by a steady rise in GDP growth over the two years to follow.
Services trade weakens
External trade has been a driver of the business cycle virtually from 2010 onwards. Swift growth in tourism before the pandemic, and pandemic-related volatility afterwards, are major factors in this pattern. Exports have suffered yet another setback, however, after a boom lasting from spring 2021 until mid-2023. The shock stems mainly from services exports, which shrank in real terms by 6% YoY in Q3. The figures indicate that, although the peak tourism season turned out reasonably well after a sluggish spring, revenue growth in the sector has not kept pace with the price level, and other subcomponents have been developing unfavourably, as we have recently discussed.
Goods export volumes were virtually unchanged between years in Q3. Goods import volumes contracted marginally, however, whereas services imports grew during the quarter. The overall contribution of net trade to output growth was therefore negative by 1.3% in Q3, and unlike in 2023, external trade has chiselled away at output growth throughout this year (see the chart above).
Investment growing slowly
Investment has been resilient in 2024 to date in spite of high interest rates, a contraction in exports, and dwindling optimism among participants in corporate expectations surveys. In all, investment grew by 2.3% in volume terms in Q3. The growth rate has been tapering off steadily year-to-date, but according to SI’s most recent data, no contraction has been seen in total investment.
The big news in Q3 was a nearly 11% YoY increase in residential investment. Public investment picked up as well, after shrinking in H1. Business investment softened, though, after a period of robust growth in H1. Because quarterly investment numbers tend to fluctuate widely, it is more useful to look at developments thus far in 2024. By that measure, investment has grown nearly 4%. Business investment is the mainstay of growth for the period, although residential investment has gained steam as well. On the other hand, public investment has been virtually flat year-to-date.
It is worth noting that investment is the national accounts subcomponent that is usually revised the most relative to SI’s first figures. In general, investment figures are revised upwards as more detailed data become available. As a result, investment growth for 2024 may well turn out somewhat stronger than the numbers above suggest.
Consumers are treading water
Private consumption is a major determinant of the national accounts, as it comprises over half of GDP. In Q3, it grew in real terms by 0.8% YoY, driven in no small part by a 3% increase in Icelanders’ overseas consumption. Furthermore, household spending on services and housing grew modestly. Spending on consumer durables contracted sharply, however – not least motor vehicle purchases, in a continuation of the trend from Q1 and Q2.
On the whole, private consumption has set the same pace this year as in 2023, although there have been some fluctuations between quarters. For example, it grew by 0.4% in real terms in Q1 and then contracted by half a percentage point in Q2. In this context, though, it should be borne in mind that Iceland’s population has grown steadily over the course of the year. In the first nine months of 2024, population growth measured 1.8% YoY. As a result, private consumption per capita has shrunk during the period.
This is due to a number of factors, including higher interest rates; changes in the composition of the population, with foreign nationals accounting for the vast majority of the increase; muted real wage growth overall; and last but not least, growing consumer pessimism early in the year, as seen in the Gallup Consumer Confidence Index. On the other hand, recent indicators suggest that Q4 might deviate from this pattern. For example, both payment card turnover and consumer sentiment have picked up strongly, according to the newest numbers, and the recent drop in inflation has fostered stronger real wage growth than was seen early in the year.
GDP expected to dip slightly in 2024
The overarching economic pattern thus far in 2024 has been one of contraction. Nevertheless, GDP growth was slightly positive in Q2, after plunging in Q1. In the first three quarters of 2024, GDP has shrunk in real terms by 1% YoY. Domestic demand has grown by 0.6%, however, fuelled by nearly 4% growth in investment and a real increase of almost 3% in public consumption. As is noted above, private consumption has been broadly unchanged between years.
A more than 2 percentage point contraction in exports concurrent with a 1 percentage point increase in imports has been the main driver of the measured contraction in GDP this year. On the exports side, the nearly 6% contraction in services exports weighs heaviest, as goods exports grew by over 1 percentage point. Imports tell a similar story. Goods imports were unchanged, while services imports grew almost 4% over the same period. Less favourable developments in services trade are therefore the cornerstone of the contraction that has been the main feature of 2024.
The results for the first three quarters of the year are somewhat below recent macroeconomic forecasts. For example, in its most recent Monetary Bulletin, the Central Bank (CBI) projected that GDP would grow by 2.5% in Q3 and remain flat YoY in real terms in 2024 as a whole, despite the contraction in H1.
In addition, we forecast in September that GDP would grow by 0.3% in 2024 as a whole. It now looks as though GDP will show a slight contraction this year, even if growth is likely to pick up in Q4. This is mainly because the contraction in exports looks set to be somewhat larger than we had anticipated. Even so, the outlook is for GDP growth to regain its footing in the coming term. In September, we forecast that GDP growth would measure 1.2% in 2025 and 2.5% in 2026. The CBI’s most recent forecast put GDP growth at 1.9% in 2025 and 2.3% in 2026. Therefore, most indicators still imply that the current turning point in the business cycle will entail a relatively soft landing without severe shocks such as elevated unemployment, widespread household financial distress, or major operational difficulties among companies.
