This is a subjective assessment and not a statistical one, and it should be borne in mind that the interactions among the factors involved – pandemic, war, and wage settlements – could develop differently than is described here; for instance, some could develop more favourably, while others could more closely resemble the pessimistic scenario.

It should be noted that the scenarios, particularly the pessimistic one, are not conceived as stress scenarios. It is possible to sketch out an even more unfavourable path than is done here, but by the same token, such a scenario is less likely to materialise. The scenarios are intended to create a framework around the developments that we consider most likely to occur during the forecast horizon. In broad terms, we consider there to be an 80% probability that actual events will be neither worse than the pessimistic scenario nor more favourable than the optimistic scenario.

GDP growth could vary greatly over the forecast horizon, depending on how these key variables develop. For instance, GDP growth could turn out 2% weaker than in the baseline if these three variables develop unfavourably in coming months. Conversely, if the same three variables develop as is described in the optimistic scenario, GDP growth could prove 1.3% stronger during the forecast horizon. Reduced activity in the economy would then be reflected in higher unemployment further ahead, while stronger economic activity would cause unemployment to decline more rapidly than in the baseline.

In particular, developments in these uncertainties will affect Iceland’s export sector, especially the tourism industry, which is one of the mainstays of GDP growth in 2022 and will also contribute strongly to growth in coming years, according to our forecast. We estimate that tourist visits to Iceland could range from 1.15 million to 1.7 million in 2022, based on the two scenarios, and that by 2024 they could range from 1.7 million to 2.3 million, given the same assumptions. Iceland’s export revenues and the ISK exchange rate could therefore develop quite differently, depending on how these three variables evolve.

Under the pessimistic scenario, the ISK could weaken markedly again this year and not return to its current level until two years from now. If the more optimistic scenario materialises, however, the ISK will presumably appreciate more rapidly and rise to a higher level further ahead.

Various developments in the ISK exchange rate, the global price level, Icelandic wages, and Icelandic house prices will ultimately result in different inflation scenarios, depending on whether the Ukraine war, the pandemic, and private sector wage negotiations develop favourably or unfavourably. More favourable developments would lead to much faster disinflation and could bring inflation back to the Central Bank’s (CBI) target around mid-2023. On the other hand, an unfavourable outcome would fan the flames of inflation in the short run, although weaker economic activity, higher unemployment, and an appreciation of the ISK would ultimately cool inflation off.

As can be seen, there is much at stake for the Icelandic economy in seeing these uncertainties evolve in a positive direction. Naturally, we have little impact on how the pandemic or Russia’s war with Ukraine plays out, but wage negotiations are firmly in the hands of the social partners. We hope that, at the very least, the outcome will not exacerbate instability and cause tumult above and beyond what external developments may bring.