Summary

After a dynamic economic growth spurt in 2021-2022, growth slowed last year, declining from 8.9% in YoY terms in Q1 to 0.6% in Q4. Íslandsbanki research forecasts modest growth this year, followed by a resurgence in the coming years. A GDP growth rate of 0.9% is predicted for this year. This represents historically slow growth, marking a cyclical transition, although most likely without annual GDP contraction.

Next year, GDP growth is expected to reach 2.3%, driven by faster consumption and investment growth, along with a rebound in goods exports. For 2026, a 2.6% growth is anticipated, with increasing domestic demand outweighing slower export growth.

Following significant improvements in foreign trade last year, a moderate trade surplus is expected throughout the forecast period. However, export growth will be slower than previously anticipated due to fewer tourists and a failed capelin season. Favorable foreign trade, among other factors, will support a moderate appreciation of the krona, expected to be 5% stronger by 2026 compared to the beginning of this year.

Inflation has eased significantly following recent spikes. Both the labor market and housing market remain robust, although relatively moderate wage agreements have reduced uncertainty about wage development in the coming years. Unemployment is expected to increase slightly, while real wages will grow moderately during the forecast period. Housing prices are likely to rise in real terms in the medium term. Inflation is expected to average just under 6% this year, declining to around 3% over the forecast period.

Persistent inflation calls for continued tight monetary stance by the Central Bank, but a gradual rate-cutting cycle is likely to begin in the latter half of this year, ending with a policy rate close to 5.5%, considered near the equilibrium rate at present.