How fast is the economy cooling? Part 2: The scenario ahead

The most recent statistics and the Central Bank’s (CBI) updated method for publication of payment card turnover data have somewhat changed the picture of the near-term economic outlook. The likelihood that tourism activity will contract this year has diminished, and it looks as though private consumption is more robust than previous figures had indicated. Thus the economy seems to be cooling more slowly than we had anticipated, and the outlook is for GDP growth in line with ÍSB Research’s spring forecast.


A few weeks ago, we discussed the economic situation in coming quarters – as it seemed to be developing at that time. We concluded that the economy looked set to continue cooling in H2/2024, most likely with very sluggish output growth. We have also recently discussed the lacklustre beginning of this year’s peak tourist season, which is naturally an important factor in the near-term outlook for the economy as a whole.

To cut to the chase, the economic situation and short-term outlook have changed noticeably since we published that analysis. On the one hand, the most recent statistics sketch out a somewhat different picture of the tourism industry’s position than the previous figures did, and on the other hand, the CBI’s updated methodology for collecting data on payment card turnover has caused a significant shift in our view of developments over the past several quarters, both in domestic households’ consumption spending and in revenues generated by foreign tourists. That being the case, we think it appropriate to take another look at developments and prospects, with an eye to these changes.

Private consumption is more resilient than previously thought

Let us look first at turnover using domestic payment cards. Because foreign entities have recently scaled up their share in the provision of payment intermediation services to Icelandic companies, growing discrepancies have developed in the CBI’s older data, which underestimated the actual increase in payment card use among Icelandic residents. The above-mentioned change in methodology caused turnover with domestic cards to increase by ISK 34bn, or 5% in ISK terms, in H1/2024. In the recent past, we have interpreted data on turnover with foreign payment cards with particular caution, but this radical change in domestic card turnover took us quite by surprise.

Our calculations suggest that based on the new data, households’ payment card turnover did not contract in real terms in June but instead grew by over 4%. In July, it grew by over 3% in price- and exchange rate-adjusted terms. Although this is a far slower growth rate than in the not-too-distant past, it surely does not indicate that households are tightening their belts aggressively at the moment – notwithstanding high interest rates, weak real wage growth, and sagging economic expectations. But here it is well to bear in mind that Iceland’s population has surged in recent quarters. According to Registers Iceland, it grew by 1.6% between the beginning of December 2023 and the end of July 2024. Growth in card turnover therefore appears to be slightly outpacing population growth at present. Another factor worth remembering is that card turnover figures do not capture households’ car purchases, and data on new registration of motor vehicles by individuals show a sharp year-on-year contraction in 2024 to date.

Will tourism contract this year?

Let us turn now to the tourism sector. We have recently reported on the marginal setback that appeared to be in the offing for the tourism industry in 2024, according to data on tourist numbers and related indicators, which showed a contraction in Q2. At that time, we thought it more likely that 2024 tourist arrivals would be lower than 2023 numbers, instead of increasing year-on-year.

But two things have happened since we released that analysis.

·         Overnight stays in June and departures via Keflavík Airport in July paint a markedly more favourable picture than data for the months beforehand do.

·         The above-mentioned change in the methodology for collecting and processing card turnover data causes turnover using foreign cards in Iceland to measure almost ISK 16bn more in H1/2024 than the previous figures indicated.

In July, the number of tourists travelling through Keflavík Airport was up by half a percentage point between years, despite a substantial YoY drop in visits by the two largest nationality groups: visitors from the US and Germany declined in number by nearly 13% and around 16%, respectively, in comparison with July 2023. This was offset by a considerable increase in travellers from Canada, the Nordic countries, the UK, and various Asian countries.

July was the first month since March 2024 to see a rise in foreign nationals’ departures via Keflavík Airport, after a modest slide in April and May and a steep drop in June. In 2024 to date, the number of foreign tourists leaving Iceland from Keflavík Airport has grown by just under a percentage point. It will be interesting to see how things turn out in August, which in the past several years has been the strongest month in terms of tourist departures via the airport.

Furthermore, bed-night figures compiled by Statistics Iceland (SI) show that despite a 9% decline in tourist departures via Keflavík Airport during the month of June, foreign nationals’ overnight stays at registered accommodations fell by only 1% YoY. Assuming that there is no significant error in the data, it appears that on average, each tourist stayed quite a bit longer in Iceland this June than in June 2023.

These figures accord relatively well with the updated payment card data showing that turnover with foreign cards contracted by only 2% YoY in June, in spite of the aforementioned 9% drop in tourist departures from Keflavík Airport. The newly published payment card figures for July 2024 broke the previous record for turnover with foreign cards, which came to just over ISK 47bn, an increase of almost 6% YoY in ISK terms.

In short, the outlook for the peak tourist season, which carries significant weight in the full-year outcome for the sector, is far more upbeat than could have been expected just a few weeks ago. As a result, it is not a given that tourist numbers are more likely to shrink than to grow, and it is quite possible that 2024 visitor numbers will be on a par with last year’s total, unless the autumn brings a profound change from the situation facing us today.

How much, then, has the near-term economic outlook changed? As before, a number of indicators imply that the economy will keep cooling for the remainder of the year. Consumers’ expectations about economic developments and prospects have dimmed, and their plans for big-ticket purchases have dwindled likewise. This is due not least to high interest rates and persistent inflation, which will cause average real wages to hold broadly unchanged this year.

Furthermore, there has been a distinct shift in firms’ staff recruitment plans, arrears have begun to rise by some measures, and the Analytica Composite Leading Indicator (CLI) suggests that growth will be weaker in the near term. These factors imply that the adjustment of the economy after a period of robust growth will continue in the quarters ahead. On the other hand, that adjustment could prove to be more gradual than was anticipated at the time we last took the pulse of the economy: year-2024 GDP growth could turn out close to the 0.9% we forecast in May, the labour market could remain relatively tight, and so forth. Although these can be viewed as signs of strength, the flip side of the coin is that all else being equal, it will apparently take longer for the economy to cool decisively enough to call for a policy rate cut.

Analyst

Jón Bjarki Bentsson

Chief economist

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