After a surge in 2021-2022, GDP growth lost steam as 2023 advanced, in what can be called a steady shift from expansion to adjustment. This trend characterised the first three quarters of 2024 as well, with GDP shrinking by an average of 1% over the period. ÍSB Research estimates that GDP contracted in real terms by 0.5% in 2024.
For 2025, we forecast GDP growth at 2.2%, driven mainly by growth in consumption, particularly private consumption, which in turn is fuelled by a more rapid rise in purchasing power, continued population growth, and partial drawdowns of accumulated savings. In the latter two years of the forecast horizon, the outlook is for slightly faster output growth measuring 2.5% in 2026 and 2.6% in 2027.
After a surplus in 2023, the current account balance weakened in 2024. The 2024 current account deficit is estimated at nearly ISK 70bn, or 1.5% of GDP for the year. We anticipate relatively more favourable developments over the forecast horizon, although the current account could well show a 0.3% deficit in 2025. For 2026, the outlook is for a more or less neutral balance, followed by a surplus of perhaps 0.5% of GDP in 2027. We expect a marginal ISK appreciation in the first half of the forecast horizon. But the likelihood of a depreciation increases over time if, as expected, prices rise faster in Iceland than in neighbouring countries.
Inflation has fallen markedly from its H1/2023 peak, yet unemployment has not risen significantly and the labour market is still close to full employment. Long-term wage agreements with most of the labour market have substantially reduced uncertainty about the situation ahead, however. The outlook is for the housing market to soften slightly during the forecast horizon, although we expect modest real price hikes. Trading partner inflation has eased, reaching target in many economies, but some uncertainty remains. We expect inflation to average 3.6% in 2025, 3.0% in 2026, and 3.2% in 2027.
Monetary easing is finally underway after a protracted period of high interest rates. We expect policy rate cuts to continue until mid-2026. We project that the policy rate will be 6.5% at the end of 2025 and 5.0-5.5% in the latter half of the forecast horizon.
