Early this summer we discussed this interesting trend, which apparently took many by surprise after last winter’s weak international trade, elevated global trade tensions, and bleak outlook for this year’s peak tourist season. At that time, we posited that the ISK would be sailing on smooth waters until well into autumn. Although currency exchange rates are often a conundrum for forecasters, this time we hit the jackpot. So this is a good opportunity to take the pulse of the situation now that autumn is here and see what the tea leaves have to tell us about the quarters ahead.

ISK on solid ground despite the current account deficit
At first glance, it seems odd that the ISK should be firming up at a time when the current account has shown such a wide deficit since Q4/2024. As we have noted recently, underlying developments in external trade have been far more favourable than appears on the surface. Large-scale inward foreign investment in data centres has made its mark on trade data, but without requiring commensurate currency flows. For instance, the CBI projected in August that if the data centre investments were set aside, Iceland’s trade account would be broadly in balance this year.

Indicators for Q3 to date imply that trade-related FX inflows have been robust during the quarter. To be sure, the goods account deficit in July and August totalled a combined ISK 78bn, according to Statistics Iceland (SI). For both months, however, the numbers reflected strong imports of investment goods, while imports contracted in various other goods categories. As was the case earlier this year, this July-August deficit probably generated smaller outflows than might have occurred otherwise.

Over the same period, the summer tourist season proved far more buoyant than anticipated. In July, foreign visitors exceeded 300,000 in a single month for the first time on record, according to Isavia’s tally of passengers at Keflavík Airport. This represented a 9% year-on-year increase in foreign nationals’ departures from the airport, on the heels of a 10% jump in June. Particularly noteworthy was the large cohort of Americans, who accounted for a third of tourist departures in July. The strength of the ISK versus the dollar does not appear thus far to have dampened Americans’ enthusiasm for travel to any measurable degree.

Monthly figures on goods and services trade are only available through June. In June, the balance on combined goods and services trade was positive by ISK 0.5bn, with a services account surplus of ISK 32bn slightly overtaking the ISK 31bn goods account deficit. In view of the above-mentioned goods trade figures and indicators of services trade in Q3 to date, it is likely that there were sizeable net inflows during the quarter, excluding the effects of data centre-related investment.

Furthermore, the commercial banks’ forward FX position was considerably smaller at the start of the tourist season than it was a year earlier. At the beginning of June, the net forward position was ISK 102bn, down from ISK 150bn in June 2024. To encapsulate briefly, this shows that forward FX sales by the banks’ customers were far smaller in scope, which suggests that this year’s tourism-generated revenues will be stronger and the impact on the FX market more favourable. This has doubtless put wind in the ISK’s sails in recent weeks and months.

In addition to FX flows due to external trade, flows relating to the financing balance also affect the ISK exchange rate at any given time. Presumably, these inflows have been fairly hefty in recent months. For instance, the CBI notes in its most recent Monetary Bulletin that companies have borrowed sizeable sums in foreign currency this summer. In addition, foreign investors increased their Treasury bond holdings by ISK 2.3bn in August, although they had reduced them by virtually the same amount in July.

It is also noted in Monetary Bulletin that the pension funds have bought only modest amounts of currency this year. According to the available figures, which extend only through May, the pension funds’ net FX purchases totalled just under ISK 19bn in the first five months of this year, as compared with ISK 36bn over the same period in 2024. As the CBI has access to more recent data on these FX purchases, its statements suggest strongly that the pension funds continued more or less in the same vein this summer.

Offsetting the pension funds’ reduced FX market activity in 2025 to date, the CBI itself has bought a considerable amount of currency since early this spring. Under its regular FX purchase programme, which it introduced in April and scaled up in June, the CBI has bought currency to the tune of just over ISK 28bn. On top of that, we estimate that the bank’s ad hoc purchases, undertaken in response to temporary surges in FX inflows, have totalled ISK 16bn year-to-date. In all, then, the CBI has bought some ISK 45bn worth of foreign currency in the interbank market thus far in 2025. We are convinced that the ISK would be far stronger now if the CBI had not gone to the market in this fashion.

Is the ISK strengthening too much?

In our opinion, the CBI’s currency purchases are having a positive impact on the economy. Apart from the obvious – that larger international reserves bolster confidence in the ISK and mitigate, directly and indirectly, the risk of a sudden capital flight-driven depreciation – a stronger ISK would be a mixed blessing, and probably a short-lived one.

In recently published figures, the CBI states that the real exchange rate has risen significantly this year, both in terms of relative consumer prices and, especially, in terms of relative unit labour costs. By the latter of these measures, it actually hit an all-time high in Q2/2025, as wages have risen far more rapidly in Iceland than in trading partner countries, but without a corresponding increase in labour productivity.

But is the ISK “too strong” in the sense that the current exchange rate is out of sync with the external balance of the economy and the real exchange rate will inevitably rebalance sooner rather than later, through a steep drop in the nominal exchange rate?

As we see it, the short answer is: probably not yet. On this point, we concur with statements made by the CBI Governor in a recent interview published on the news website Innherji, in which he said that he considered the current real exchange rate close to what could be called its equilibrium value, as the equilibrium real exchange rate may well have risen alongside the increased resilience of the domestic economy.

 In view of this summer’s tourist season and indicators of other exporters’ earnings, Iceland’s export sector still appears able to tolerate the current real exchange rate despite the attendant challenges to its competitive position. It also helps that marine product prices are relatively high. Although the current account deficit has been hefty in the recent past, it is due in part to the temporary impact of rapid data centre development. Indeed, as is mentioned above, the CBI estimates that if the data centres are omitted from the equation, this year’s trade balance will probably turn out broadly neutral. The interest rate differential with abroad is still fairly wide, and if the pension funds step up their foreign investments, the CBI will probably scale down its regular FX market intervention accordingly. For the near future, then, the ISK appears to rest on a solid foundation.

The outlook further ahead is less certain, however. If wages and prices continue to rise faster in Iceland than in trading partner countries – particularly if unit labour costs are not held in check by stronger productivity growth – the real exchange rate will steadily put growing pressure on the nominal exchange rate.

In short, three scenarios come to mind:

• The most likely one, in our opinion, is that the ISK will weaken gradually in the next few years. Large entities such as the pension funds and foreign investors, together with the CBI itself, have functioned as shock absorbers, cushioning against potential exchange rate volatility and reducing the probability of a sudden depreciation, unless some sort of shock should hit the export sector. In our macroeconomic forecast from May, we assumed that the average EURISK exchange rate would be just over 148 in 2027, which translates to an ISK 3-4% weaker than it is currently.
• The possibility cannot be excluded that the ISK will appreciate further in the quarters ahead. If it did so, the real exchange rate would steadily grow stronger than is consistent with external balance, the current account deficit would balloon, and the nominal exchange rate would fall that much farther in the end.
• There is also the possibility that the ISK will weaken substantially this winter – for instance, if the winter tourist season is sluggish or fish prices fall sharply. Such a situation would ultimately be the mirror image of scenario #2: Iceland would become a relatively inexpensive travel destination and export sectors could enjoy a stronger competitive position, and concurrently, the inflationary impact of a weaker ISK would curtail private consumption growth. This would be not unlike the situation that emerged about fifteen years ago.

Throughout the history of the Republic, the saga of the Icelandic króna has been the tale of a trend towards weakness against major currencies, interspersed with a few (usually brief) spurts of appreciation and stable periods of varying length. If there is no change in our tendency to hike wages and prices faster than is consistent with increased value creation and modest inflation, that saga will continue.