As long as uncertainty prevails about the global trade barrier landscape, the risk exists that companies will postpone investment decisions, which could ultimately throw sand in the gears of GDP growth, both in the US and worldwide. The same can be said of households’ consumption spending, as individuals will presumably avoid big-ticket purchases such as cars, home appliances, and overseas travel during a period of this much uncertainty. Expectations surveys taken among US consumers and company executives have shown greater pessimism about the economic outlook and more pronounced concerns about inflation.

How will this affect the global economy?

As long as uncertainty prevails about the path a possible trade war will take, it is impossible to speculate about the economic impact it will have, either globally or in Iceland. The OECD has published an interesting scenario analysis in a recent macroeconomic forecast. The forecast includes a scenario assuming a flat 10% tariff on non-commodity imports to the US and commensurate retaliatory tariffs imposed by all other countries. The OECD’s baseline forecast actually entails some impact from the tariffs already announced in March and assumes somewhat slower GDP growth and more persistent inflation than its previous forecast. It should also be borne in mind that, on average, the tariffs announced thus far by the US are higher than the 10% assumed by the OECD.

As the chart suggests, the estimated negative on GDP growth in advanced economies (the backbone of the OECD) are considerably stronger on the US itself than on the global economy as a whole. The trade war will also deliver quite a blow to Canada and Mexico, while the impact on the eurozone and the largest countries in Asia is projected to be much more modest. The estimated impact on the US is markedly greater than on other advanced economies, which hardly aligns with the purpose of the tariffs as described by the US authorities.

Moreover, the OECD considers the possibility of far more persistent global inflation a key risk in connection with the trade war, particularly for countries in North America. In the end, it would also spread to Iceland, as the transmission of foreign prices to domestic inflation is quite strong, and imported goods account for a large share of Icelanders’ consumption basket. If inflation develops as is sketched out in the OECD scenario, central banks will be in a bit of a bind, and policy rates in Iceland and abroad could temporarily be higher as a result.

Tariffs on Iceland are more moderate than on neighbouring countries

It appears that the tariffs announced by the US authorities on 2 April were calculated as a ratio of the goods trade deficit to each country’s total goods exports. The tariffs on Iceland therefore fall into the lowest category, 10%, as Iceland has generally run a small goods account deficit vis-à-vis the US. For comparison, EU countries are faced with a 20% tariff, and Norwegian goods imported to the US will carry a 15% tariff.

On this front, the fact that the US should focus solely on goods trade is of benefit to Iceland. As for services trade, Iceland has been running a handsome surplus vis-à-vis the US in recent years, owing mainly to Americans’ keen interest in travelling to Iceland. In 2024, more than one of every four tourists visiting the country came from the US, with other countries trailing far behind.

Last year, Iceland was a net importer of US goods to the tune of slightly over ISK 6bn, whereas its net exports of services to the US totalled ISK 219bn for the same period.

Fish, pharmaceuticals, and medical products the mainstay of exports to the US

Although the US is an important trading partner for Iceland, its share in Iceland’s goods exports is relatively modest, at 12% (ISK 110bn) in 2024. Seafood and healthcare-related goods account for the vast majority of these exports. Exports of fish came to ISK 46bn last year. Cod accounted for nearly half, although haddock and farmed salmon exports weighed heavily as well. Just over ISK 39bn worth of exported goods were classified by Statistics Iceland (SI) as medical products and equipment. That category includes drugs manufactured by Alvotech, Oculis, and others; products such as wound dressings produced by Kerecis; prosthetics and support gear made by Össur; and sleep research equipment made by Nox Medical. It should be noted that aluminium, which constitutes a large share of Iceland’s exported goods, is sold almost entirely to Europe and is therefore not directly affected by the tariffs. In addition, pharmaceuticals are exempt from the tariff regime, at least for the time being, which should come as a relief to Icelandic pharmaceuticals companies that sell drugs to the US.

The impact of a trade war on Iceland is highly uncertain

It is exceedingly difficult to project with any certainty what impact the tariffs already announced by the US will ultimately have on the Icelandic economy. Even so, there are a few points that will be of critical importance going forward.

First, Government authorities must make every effort to ensure that Iceland’s trade with its main trading partners remains free of tariffs and other barriers insofar as is possible. Leaders of several key countries have responded to the newly announced tariffs by threatening to impose their own tariffs on goods imported from the US. Thus far, these responses have centred on measures vis-à-vis the US rather than on broad-based tariffs on imports from trading partners.

If tariffs on Iceland’s exports are largely limited to the US, there will be correspondingly less impact on domestic inflation. Furthermore, it will be easier for exporters to sell their goods – marine products, for instance – to large markets other than the US, without suffering significant losses. Moreover, it bodes well that the Icelandic authorities appear determined to address this issue firmly, and as yet there are few indications that Iceland will end up squeezed between trade barriers on both sides, although the possibility cannot be excluded.

It is virtually beyond doubt that the tariffs will have a negative impact on demand and GDP growth in Iceland, although certain sectors or companies may benefit from proportionally low tariffs in a global context. We think it quite likely, though, that the blow to the Icelandic economy will not be too onerous, as long as a full-blown trade war does not completely change the world trade environment.

One major uncertainty concerns the impact on American tourists’ interest in visiting Iceland. Recent surveys carried out in the US suggest that Americans are very keen to travel. That could change, however, if the adverse effects of the tariffs start to cut into US households’ disposable income in the coming term. A significant contraction in US nationals’ travel to Iceland would quickly chip away at the tourism industry, which is already facing greater near-term uncertainty than was envisioned at the start of the year.

As regards the impact on inflation and the policy rate, the picture is murkier. Inflation will probably be affected in two ways:

• As is noted above, the global price level affects domestic inflation fairly strongly, through what is called imported inflation. We therefore think it more likely that a trade war’s short-term impact on key trading blocs would be to push inflation higher in Iceland.
• Further ahead, however, a tariff-related downturn in economic activity will probably ease global inflationary pressures, which, together with the potential dampening effect on demand and exports in Iceland, could gradually offset the aforementioned cost effects and even overtake them if the trade war proves onerous and protracted.

In the quarters immediately ahead, inflation could turn out higher than it might otherwise, perhaps prompting the Central Bank (CBI) to lower interest rates more slowly. These effects should reverse later on, however, and falling inflation and a larger slack in the economy should make it easier for the CBI to stay the course and keep unwinding the policy stance.