Higher unemployment, reduced labour shortages

Closer scrutiny of developments in registered unemployment, compiled by the Directorate of labour (DoL), shows that the jobless rate inched upwards in 2025, to an average of 3.9%. There was a somewhat unexpected uptick in unemployment in the latter half of the year, stemming mainly from shocks in export sectors, including tourism and metals manufacturing. In spite of this, the labour market has remained relatively stable, and many firms appear able to adjust their staffing levels through flexibility-enhancing measures rather than layoffs.

Figures on immigration and the findings from the Gallup survey of Iceland’s largest firms also give important indications of the state of the labour market. After surging in recent years, immigration has slowed markedly. It started to pick up strongly in 2022, when there were labour shortages, and at the peak, more than 3,000 persons moved to Iceland in a single quarter. Immigration started to lose pace at the beginning of 2024 and has been on the decline ever since.

Gallup’s most recent information from Iceland’s largest firms indicates as well that labour market tightness has eased. According to the Gallup survey, 10% of participating companies consider themselves understaffed – the smallest share since the COVID pandemic in 2020. In 2022, when the labour market was particularly tight, the share of companies reporting labour shortages peaked at 56%. Both the slowdown in immigration and companies’ greater ease in filling job openings suggest that labour market tension is tapering off.

Unemployment set to peak in 2026

In our macroeconomic forecast, we project that unemployment will continue to rise this year. We expect it to average 4.5% in 2026 as a whole, largely because of the changed situation in export sectors and the cooler economy, which will curb labour demand in H1. Nevertheless, the Icelandic labour market is known for its flexibility, and the outlook is for unemployment to turn downwards again in H2. Thereafter, we expect it to average 3.8% in 2027 and 3.5% in 2028, close to its equilibrium level.

The CBI’s Monetary Bulletin, published this past Wednesday, points out that the employment outlook has deteriorated markedly, as is indicated by the job vacancy rate and the responses in the aforementioned Gallup survey. The CBI forecasts that unemployment will average 4.8% this year and then subside to 4.3% in 2027. As can be seen, the CBI is more pessimistic about unemployment than we are. However, the CBI bases its forecast on the LFS, which fluctuates more than the Directorate of Labour’s (DoL) registered unemployment rate does. Furthermore, SI’s definition of unemployment is broader than the DoL’s registered unemployment rate. We base our forecast on the DoL rate.

Wage developments shaped by long-term collective bargaining agreements

As in recent years, wage developments will continue to be shaped by long-term wage agreements extending through 2028, provided that the assumptions underlying the contracts hold. Despite the wider slack in the labour market, wages look set to continue rising in line with contractual provisions. Wages rose by 7.9% year-on-year in 2025. While this is just above the long-term average, the average pay rise over the past decade is 7.6% per year.

We anticipate slightly smaller pay rises in coming years. Our forecast assumes a 6.6% average increase in 2026, with modest wage drift over the forecast horizon, owing to reduced labour market tightness. We project that wages will rise by 6.0% in 2027 and 4.9% in 2028, which is below the recent average. Real wages will continue to rise if wages and inflation develop as we have forecast.

What’s on the horizon for the job market?

It is obvious that a slack has opened up in the labour market. This indicates reduced tension in the coming term, which should contain wage drift and thereby support disinflation. On the other hand, long-term collective bargaining agreements will continue to shape wage developments in the years ahead, and the outlook is for pay rises to be fairly sizeable, albeit smaller than before. We hope this will suffice to reduce persistent inflation in the coming term. In our opinion, though, wage developments are one of the factors that will prevent inflation from reaching the CBI’s target in the next few years.