A swift landing for the Icelandic economy?

The Icelandic economy shifted abruptly from expansion to adjustment in 2023. GDP growth fell to a three-year low in Q4, and a sharp contraction in imports was the only reason it did not dip into negative territory. The outlook is for a continued adjustment this year, and recent indicators imply that the economy has kept cooling in 2024 to date.

According to Statistics Iceland’s (SI) newly published preliminary figures, GDP grew by 0.6% in Q4/2023, the weakest growth rate since the post-COVID recovery started in spring 2021. Private consumption, investment, and services exports contracted year-on-year, and the fact that output growth was positive at all was thanks only to an even larger contraction in imports, plus modest growth in goods exports and public consumption.

As the chart shows, the Icelandic economy underwent something of a sea change in 2023. Output growth measured nearly 9% in Q1, supported by still-buoyant services exports, private consumption, and investment. But the growth rate faltered quarter by quarter as consumption and investment shrivelled, ultimately contracting, and export growth slowed markedly, although it remained positive.

Positive contribution from net trade

As is noted above, GDP growth in Q4, while tepid, was due mainly to a 6% contraction in imports, which helped firm up the national accounts. This strongest contraction in imports in nearly three years is attributable to dwindling domestic demand and a reduced need for inputs in the export sector.

Another new twist was that export volumes were flat YoY in Q4, the first time since Q1/2021 that exports have not been positive. As the chart indicates, exports have braked suddenly, stagnating after a period of double-digit growth in 2021-2022. Actually, goods exports grew by 3% YoY in Q4 but were overshadowed by the first contraction in services exports since early in the pandemic. The downturn in services exports is doubtless due to the seismic activity on the Reykjanes peninsula and its impact on tourism in the final months of 2023. Total exports grew by just under 5% in 2023, while imports grew 1.4%. The contribution of net trade to output growth was positive by 2.9%.

Investment shrank slightly in 2023

Investment contracted by 0.6% last year, and the above-described pattern – a marked reversal within the year – can be detected. This is particularly true of business investment, which carries more weight in the national accounts than public and residential investment combined. Business investment grew in volume terms by almost 10% in Q1/2023 but contracted by 15% in Q4, and over the year as a whole it grew by just under a percentage point.

Residential investment moved in the opposite direction, however, contracting by nearly 8% at the beginning of the year but growing by over 9% in Q4. This is cause for celebration, given the stubborn shortage of newly built homes in the period beforehand, and as a result, the housing market has become better balanced in recent quarters, after a period of sky-high house price inflation earlier in the decade. For 2023 as a whole, residential investment was virtually unchanged between years.

The third main component of investment – public investment – contracted by over 6% in 2023, however, although it is often highly volatile from quarter to quarter. The 2023 contraction comes on the heels of several years of strong growth driven partly by discretionary fiscal measures aimed at cushioning against the pandemic-induced blow to the economy.

Households furled their sails on spending

Private consumption is one of the largest subcomponents of the national accounts. As is noted above, it tacked abruptly in 2023, after several years of robust growth. In Q1/2023, it grew by nearly 5%, but by Q3 it had turned negative, and in Q4 the contraction strengthened to just over 2%. For the year as a whole, private consumption grew by about half a percentage point, the most sluggish YoY growth rate since 2010, apart from 2020, the year the pandemic struck.

According to SI’s news release, consumption items such as motor vehicles, food, clothing and footwear, and alcoholic beverages were the primary drivers of the Q4 contraction, plus a continuing

decline in consumption spending during travel overseas. This lines up well with indicators such as payment card turnover, Icelandic nationals’ departures via Keflavík Airport, and retail sales during the period, as well as developments in the Gallup Consumer Confidence Index.

A swift landing after a short, sharp cyclical upswing

GDP growth measured 4.1% in 2023, somewhat outpacing our forecast. This stronger-than-expected outcome is due to revisions of data for previous quarters in 2023, however, and does not change the big picture, which clearly shows a turning point in the economy. The mainstay of last year’s output growth was the surge in services exports, with assistance from favourable goods trade and an uptick in consumption, all of which was offset by a contraction in total investment.

SI data show a 4.1% increase in total hours worked in 2023. According to this, labour productivity growth was all but flat and real wage growth probably on fairly shaky ground, although it is best to interpret such short-term figures with caution.

SI also revised previous years’ national accounts data concurrent with this latest publication. Figures for 2020-2022 were revised upwards: for 2022, GDP growth is now estimated at 8.9% instead of the previous 7.2%; for 2021, it was revised upwards from 4.5 to 5.1%; and for 2020, the contraction is now estimated at 6.9% instead of the previous 7.2%. According to SI, the main difference lies in a revision of business investment, which is considered to have been underestimated significantly in previous figures. Furthermore, it is worth bearing in mind that year-2023 data could well be revised substantially at a later date, just as 2020-2022 figures were this time.

In our macroeconomic forecast, published in late January, we projected that 2024 would in many respects turn out to be a mirror image of 2023. Recent indicators imply a continuing contraction in private consumption, and actually, the economy seems to be still cooling rapidly after the brief boom in 2021-2022. Nevertheless, because households’ and businesses’ financial position is sound overall and the employment situation is still quite good, it would be an exaggeration to call it a hard landing. We prefer to characterise it as a swift but largely safe landing. Later this year, the economy looks set to pick up steam gradually, with output growth approaching 2%, according to our projections. For the next two years, we expect growth to accelerate, with a faster increase in domestic demand offsetting weaker export growth with room to spare. As is frequently the case with such forecasts, there are no

signs of impending economic turmoil, but as the experience of recent years has shown clearly, unexpected events in Iceland and abroad could easily upset that apple cart. Fortunately, though, the key pillars of the domestic economy are strong overall, providing increased resilience in the face of good times and bad.


Jon Bjarki Bentsson

Chief economist