GDP growth likely to pick up in H2/2021
GDP growth is expected to be relatively robust in 2021, at 3.2%, with most of the growth concentrated in H2, as the COVID endgame and the recovery of tourism will be the major determinants of overall economic developments during the year. GDP growth will stem largely from export growth, plus moderate growth in consumption and investment. Prospects for tourism are highly uncertain, however, and GDP growth could easily range anywhere between 1% and 5%, depending on how tourist arrivals develop.
The sizeable contribution of public investment to investment growth in 2021 is due to the Government's investment initiative. In addition, the outlook is for business investment to gain steam in H2 and grow steadily over the period. On the other hand, residential investment is expected to contract, and a reduced supply of new properties coupled with constant demand will probably push prices higher during the year.
Unemployment will probably be high until midyear, but with a rebound in tourism, increased construction activity, and growing demand for domestic goods and services, the labour market situation should improve markedly in H2. A recuperating labour market and, for many individuals, rising purchasing power will support private consumption growth over time.
To a large extent, developments in the ISK will reflect developments in tourism-generated foreign exchange revenues. The ISK will probably be somewhat on the defensive early in 2021, but there is a growing likelihood that it will appreciate as the year progresses. The ISK is one of the main drivers of developments in inflation, which will probably be a mirror image of last year’s pattern. In the first months of the year, inflation will be around 4.0%, the upper deviation threshold of the CBI's inflation target, but then it will taper off quickly, probably aligning with the target by the year-end. Furthermore, the outlook is for a very low policy rate throughout 2021, and for long-term rates to be close to the lowest ever seen in Iceland.
If the pandemic subsides before next winter, there is a strong probability that 2021 will see the end of the Corona Crisis and the beginning of a new growth phase. Such an outcome is fostered by the strength of private and public sector balance sheets (in historical and international context) at the onset of the pandemic, as well as Iceland's successful economic policy response after the disease started to spread.