Iceland Economic Forecast

Annual economic growth likely slowed in the second quarter. Domestically, price pressures remained nearly four times above the Central Bank’s target despite easing from Q1. Moreover, the Central Bank hiked rates aggressively in May in a bid to tame inflation, boding ill for credit and investment. As a result, purchasing power will have remained under pressure in Q2. That said, the unemployment rate fell in the quarter, which likely cushioned private consumption somewhat. On the external front, merchandise imports declined at the steepest annual pace since Q4 2020 in Q2, while goods exports fell at the quickest year-on-year rate in three years. Furthermore, total hotel stays rose 15% year on year in Q2, the slowest expansion in over two years. These developments hint at a weak external sector performance in Q2.

In July, inflation dropped to a 14-month low of 7.6% from June’s 8.9% on softer price increases for housing and utilities, as well as transport. In the remainder of H2, inflation should ease further from current levels, thanks to tighter monetary policy and softer activity. Still, it will remain markedly above the Central Bank’s 2.5% target and be the highest in the region on average in 2023.