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Icelandic Financial Market Digest 24. maí

Publisher: Íslandsbanki Research • Resp.Editor: Ingólfur Bender

Updated macroeconomic forecast 2018-2020

After a period of rapid GDP growth in the middle of the decade, the business cycle is on the decline. GDP growth has eased and is driven increasingly by households and the public sector rather than businesses. We project output growth at 2.6% this year, 2.4% in 2019, and 2.6% again in 2020. The pace of growth will be close to potential, and the output gap will narrow steadily. 

The economy is therefore moving towards greater equilibrium by various measures, and if developments are in line with our forecast, a relatively soft landing can be expected to follow Iceland’s long, steep upward cycle. We now expect somewhat stronger GDP growth in the coming term than in our last forecast, despite the prospect of weaker growth in exports. In part, this is due to base effects, as growth was weaker in 2017 we had anticipated. Furthermore, the outlook is for considerably more public sector activity over the forecast horizon than we previously assumed, and residential investment looks set to grow more than we had forecast.

Current account surplus tapering off

The outlook for 2018 and the years to follow is for considerably weaker growth in both imports and exports than in the recent past. Import growth will outpace export growth in both years, however, and the contribution of net trade to output growth will therefore be negative. 

 

The current account surplus narrowed somewhat in 2017, to 3.7% of GDP, after having been very large for four years running. The outlook is for a high real exchange rate to cause the surplus to diminish steadily and perhaps close entirely by the end of the forecast horizon.
 
We forecast that it will measure 3.0% of GDP this year and 1.3% of GDP in 2019, and then be broadly in balance in 2020. That said, there are few indications that it will turn sharply negative in the next few years, provided that the real exchange rate does not rise too steeply from the current value and terms of trade do not deteriorate excessively. 

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