Real wage growth has slowed considerably in the recent past, after surging from around the middle of the decade and peaking in 2016 at 9.5% year-on-year. This unusually swift growth was due to a combination of factors, with large pay hikes coinciding with low inflation caused mainly by the appreciation of the ISK. In 2018, however, real wage growth averaged only 3.7%, owing to smaller nominal pay rises and higher inflation than in the years beforehand.

This reflects the front-loaded wage agreements made in the middle of the decade and differences in exchange rate pass-through to domestic inflation. It can be said, then, that much of the scope for real wage growth that developed during the boom of the mid-2010s was used up sooner rather than later. Even so, a real wage growth rate of “only” 3.7% is quite strong in international context.

Purchasing power and private consumption go hand-in-hand

Developments in purchasing power are one of the wellsprings of private consumption in Iceland. Just over a decade ago, the link between the two weakened noticeably because households relied heavily on credit to finance consumption spending. This has not been the case in recent years, however, as can be seen in the reasonably close correlation between real wage growth and private consumption, as well as in the good news that households have scaled down their debt during the current business cycle.

The wage agreements recently finalised for a large share of private sector workers have now been approved by union members as well as employers. This means wages for the groups affected with rise significantly from April onwards. Agreements are still pending for various groups of tradesmen and public sector employees, but we hope the parties concerned will negotiate contracts broadly similar to those already approved by employees. But there are no guarantees, as contracts based on fixed rather than proportional increases tend to be less attractive to employees further up the pay scale.

Outlook for weak private consumption growth in 2019

In our most recent inflation forecast, we project that wages will be, on average, 5.2% higher this year than in 2018 and that prices will be 3.3% higher. If those assumptions are borne out, real wage growth will measure 1.8% in 2019. This is weaker growth than Icelanders have seen in the past five years, although many workers in neighbouring countries would welcome such a rise in purchasing power. If population growth turns out weaker this year, as SI has projected, private consumption growth will probably lose momentum.