The Icelandic economy has been recovering strongly after a brief but abrupt contraction in the wake of the pandemic. Output growth measured 7.2% in 2022, its strongest since 2007. ÍSB Research projects year-2023 GDP growth at 2.2%, considerably below our last forecast. The downward revision is due mainly to weaker growth in private consumption and investment. Export growth will be the main driver of output growth this year, while the contribution from domestic demand will be much smaller than in 2021 and 2022. We project GDP growth at 2.6% in 2024 and 3.0% in 2025.

The outlook is for the current account balance to improve after a sizeable deficit in recent years, thanks largely to rapid export growth and more sluggish growth in demand. More favourable external trade and other factors help buttress the ISK. According to our forecast, the ISK will be approximately 5% stronger at the end of the forecast horizon than it was in August 2023.

Inflation has proven stubborn but will give way during the forecast horizon, owing in particular to a more tranquil housing market and greater price stability abroad. Demand pressures in the labour market will subside gradually, and the outlook is for real wage growth to resume as soon as this year. Persistent inflation will call for a tight monetary stance, with the policy rate set to peak at 9.5% before the year-end. A gradual monetary easing phase could begin in spring 2024, provided that inflation develops in line with our forecast.