Iceland Economic Forecast

The economy tapped on the breaks in Q2, when GDP growth ebbed to 4.5% year on year (Q1: +7.1% yoy). The moderation was nearly broad-based: Year-on-year growth in goods and services exports, government spending and private consumption decelerated in Q2 from Q1. However, fixed investment returned to growth, expanding 1.6% despite elevated interest rates (Q1: -0.8% yoy) and preventing a sharper GDP slowdown. Additionally, price pressures eased slightly in Q2 from Q1, and the unemployment rate decreased, providing some support to spending. Moving to Q3, the outlook is rosier: Inflation was lower in July–August than in Q2, and the unemployment rate dropped from Q2 in July, alleviating further pressure on household budgets. Less positively, in July, hotel stays fell year on year for the first time since March 2021; it seems that the tourism sector is no longer recovering from the pandemic.

In August, inflation inched up to 7.7% from July’s 7.6% due to stronger price increases for transport, which more than offset softer price pressures for food and housing and utilities. This year, inflation will ebb only marginally from 2022’s level and average over three times higher than the Central Bank’s 2.5% target. It will also be by far the highest in the region in 2023.