Eco­nom­ic fore­cast for 2024-2026: Growth des­pite high in­terest rates

Following a period of robust economic growth in the post-pandemic era, a turning point has now been reached. We forecast very limited economic growth in the coming years, or 0.9% this year, 2.2% in 2025 and finally 2.6% in 2026. High interest levels will retard economic growth through less consumer consumption and because various investments will be delayed in wait of lower interest rates. We expect capital formation to increase by a mere 0.1% this year and private consumption by 0.9%. We forecast continued yet much slower growth in the travel sector and a 3-4% increase in visits to Iceland per annum in the coming years.

The Monetary Policy Committee of the Central Bank of Iceland most recently met in March and its attitude was rather stricter than we had anticipated. We expect that interest rates will be kept high until there are clear signs that inflation is declining.

The outlook is slightly better towards the forecast horizon. We forecast receding inflation and expect inflation to decrease to 5.5% in the fourth quarter of this year and for a rate-cutting cycle to begin at the same time and continue throughout the forecast period. Various factors that affect inflation must develop favourably for our forecast to hold and for the Monetary Policy Committee to initiate rate cuts. Collective bargaining agreements remain open for a large part of the labour market and it remains to be seen to what extent the government manages to prevent increased expenditure from fuelling inflation.

Uncertainty remains a factor in the forecast, most notably represented by international war efforts that may impact the economies of our business partner countries and thereby Iceland. In addition, the seismic and volcanic activity on the Reykjanes peninsula is on-going and could pose a threat to local infrastructure and tourism in the area.

Key points from the forecast:

• Our forecast assumes continued economic growth in the coming years, 0.9% this year, 2.2% in 2024 and 2.6% in 2025.
• Inflation will remain persistent and measure on average 6% this year, if our forecast holds, before dwindling to 4.4% in 2025 and 3.5% in 2026. We do not expect the rate-cutting cycle to begin until the fourth quarter of this year but it will then continue to the forecast horizon.
• We expect high interest rates to continue to restrain private consumption; it will nevertheless be slightly more robust than in 2023, when consumption grew by a mere 0.5%. According to our forecast, private consumption will increase by 0.9% this year, 1.8% in 2025 and 2.5% in 2026. Public consumption grows slowly but steadily throughout the period, by 1.5-1.9% annually.
• We expect 2.3 million tourists to visit Iceland this year, 2.4 million in 2025 and 2.5 million in 2026. Total export will increase by 2.9% this year, if our forecast holds.
• We anticipate slow appreciation of the Icelandic króna (ISK) and for the euro to cost ISK 148 at the end of this year and ISK 146 at year-end 2025.
• We forecast a small trade surplus throughout the period, with a surplus in the balance of services counteracting a deficit in trade of goods.
• Wages have risen sharply in recent years, both through generous contractual increases but also driven by wage drift. This spring, collective bargaining agreements were concluded for a large part of the labour market, providing for conservative wage hikes, and we expect a 6.6% wage increases this year, 6.1% in 2025 and 5.5% in 2026. Purchasing power will as a result increase all years.
• Unemployment may also increase slightly as demand slows and tension in the labour market recedes. We expect registered unemployment to average 4% this year, 4.2% in 2025 and 3.9% in 2026.
• We are of the opinion that inflation has peaked yet that it will recede but slowly and not fall below the upper tolerance limit of the CBI until 2026.
• The policy rate will not be lowered until the fourth quarter of this year, if our forecast holds. We subsequently expect a fairly steady rate-cutting programme to place the policy rate at 4.25% at the forecast horizon.
• Capital formation increases as the forecast period progresses and interest rate levels fall. Total capital formation will only increase by 0.1% this year, by 2.0% in 2025 and 3.3% in 2026.
• Demand pressure appears notable on the residential housing market despite high interest rates, and we expect housing prices to measure in general 7% higher this year than in 2023. We forecast an 8.8% increase in housing prices in 2025 and a 7.7% increase in 2026.