It is clear from Statistics Iceland’s (SI) newly published national accounts data, which extend through Q2/2024, that the economy will continue to adjust for most of this year. SI estimates that GDP shrank by 0.3% year-on-year in real terms. The contraction is due both to a turnaround in external trade and to a downturn in private consumption. It comes in the wake of a 3.5% contraction in Q1, according to revised figures from SI.
Economic contraction in H1/2024
The Icelandic economy shrank by nearly 2% in real terms in H1/2024. Unfavourable developments in external trade and a contraction in private consumption more than offset growth in investment and public consumption. The outlook for the year is for negligible output growth, if any, and for 2024 to be a year of adjustment after a period of surging growth.
Exports on the defensive
External trade has been a leading driver of the business cycle over the past fifteen years or so, particularly with the emergence of tourism as one of the main sources of export revenues. As the chart shows, exports have suffered significantly after several years of strong growth that started with the waning of the pandemic. Services exports, for instance, contracted by over 10% in Q2/2024 – the first year-on-year contraction in services exports since early in the pandemic. We have recently discussed developments in the services account balance, and the most recent figures are consistent with a contraction in tourism revenues in Q2: a 6% drop in departures from Keflavík Airport, and a nearly 10% decline in bed-nights at registered accommodations during the period.
Furthermore, the deficit on goods trade was larger in Q2 than in the same quarter of 2023. The balance on combined goods and services trade was negative by just over ISK 22bn in Q2, whereas it was positive in Q2/2023. The contribution of net trade to GDP was therefore negative by 3% during the quarter.
Investment holds its own
Investment has been strong in the recent term, rising interest rates notwithstanding, and the new figures from SI show no change in this trend. The overall growth rate in Q2 was about 4.6%, with 7% growth in business investment and 3% growth in residential investment offsetting a more than 4% contraction in public investment.
SI’s investment figures can fluctuate widely from quarter to quarter, and it can therefore be more useful to examine data for the first half of the year, which show that investment grew by 4% year-on-year in H1/2024. This was driven largely by a more than 5% increase in business investment, as well as a rise of almost 7% in residential investment. These were offset by a nearly 5% downturn in State and municipal investment.
In addition, it is worth remembering that SI’s investment figures are often subject to sizeable subsequent revisions – most often upward revisions. For example, SI now estimates that investment grew by 1.6% in 2023, whereas previous figures indicated a contraction of 0.6% for the year.
Consumers pull back
Indicators of developments in private consumption have been rather ambiguous in recent months. On the one hand, households have scaled down their new car purchases, have travelled abroad less frequently, and have shown greater pessimism according to the Gallup Consumer Confidence Index, yet on the other hand, households’ payment card turnover suggests robust consumption, and gradually rising real wages should support consumption to an extent.
According to the newly published figures, private consumption shrank by 0.9% in Q2. SI points out that this downturn is due largely to the sharp contraction in the purchase of cars and other consumer durables, but that households are purchasing fewer services as well. Furthermore, Icelanders’ private consumption abroad shrank by 3% in real terms, whereas domestic consumption (apart from the above-specified items) increased. This breakdown by SI therefore appears to explain quite effectively the divergent developments we have seen recently in consumption-related indicators.
2024: a year of living prudently
As is noted above, GDP shrank in H1/2024. The contraction totalled 1.9% for the period, and it stemmed entirely from a negative contribution from net trade, as domestic demand – which reflects consumption and investment adjusted for inventory changes – was flat during the period.
It is worth noting that these GDP figures are well below the Q2 growth rate of 2% predicted by the Central Bank (CBI) in its most recent issue of Monetary Bulletin. It can thus be said that when the CBI Monetary Policy Committee convened for last week’s policy rate decision, it had in hand a rosier picture of the state of the economy than SI’s new numbers suggest.
The forecast in the new issue of Monetary Bulletin projected GDP growth for 2024 at 0.5%, which was a downward revision of 0.6 percentage points from the May forecast. The macroeconomic forecast we issued in May provided for 0.9% GDP growth this year. Assuming that the newly published H1 figures are not revised sharply upwards (which is far from impossible), it appears that both we and the CBI were overly optimistic this spring and that year-2024 output growth will be virtually flat. It is also worth noting that the most recent statistics, forward-looking indicators such as the Analytica Composite Leading Indicator (CLI), and expectations surveys suggest that households and businesses will be playing defence rather than offence with regard to consumption and investment – at a time when this year’s growth prospects for tourism and other key export sectors are relatively dim.
