According to national accounts data just published by Statistics Iceland (SI), GDP growth measured 1.1% in Q3, the most sluggish single-quarter growth rate since Q1/2021. It also represents an abrupt reversal relative to the first two quarters of this year. It is worth noting that in its most recent Monetary Bulletin, the Central Bank (CBI) projected Q3 output growth at 1.75%, considerably above the actual growth rate published by SI. Actually, it is mainly the 3% contraction in imports that pushed the GDP growth figure into positive territory, as national expenditure (which reflects domestic demand) shrank by 1.2% and exports grew by only half a percentage point between years.
GDP growth in Q3 the slowest in 2½ years
Domestic demand contracted in Q3, in a clear sign that the economy has turned a corner. GDP growth for the quarter was the weakest since early 2021 and was sustained by a favourable contribution from net trade. Declining tension in the economy could reduce the need for further policy rate hikes in coming quarters.
Export growth has been a major driver of output growth in recent quarters but contributed relatively little in Q3, owing to a 3.7% year-on-year contraction in goods export volumes. Services exports, on the other hand, increased by 7.4% in volume terms during the quarter, due mainly to tourism, as we have reported recently. Total exports have grown by 5.7% in 2023 to date, however, and the 15% jump in services exports weighs far heavier than the 1.3% contraction in goods exports.
As is noted above, imports contracted by 3% in Q3, owing entirely to the YoY contraction in goods imports, which in turn is mostly a reflection of weaker domestic demand. Over the first nine months of 2023, however, imports were flat year-on-year.
Prolonged contraction in residential investment
Investment has fluctuated widely from one quarter to the next in SI’s national accounts in the recent term, as it often does in a small economy with a relatively volatile business cycle. For instance, it contracted by over 4% in Q3, driven by a 6% decline in residential investment and a 23% drop in public investment, which more than offset the 3% increase in business investment. SI points out that in Q3, growth in business investment and the steep drop in public investment are both due partly to base effects stemming from a major transfer of real estate from the private to the public sector, which took place a year ago.
It is more instructive, however, to examine developments in investment over the first three quarters of the year and put this longer period into the context of investment in recent years. This exercise shows that investment contracted by 1.3% YoY, after growing by nearly 8% in 2022 and almost 11% in 2021. Over this three-quarter period, business investment grew nearly 5%, while residential investment shrank in volume terms by over 7% and public investment by more than 13%. Residential investment has now contracted unabated for more than two years, although SI points out that as a share of GDP it is close to the average from 1995 to the present. Nevertheless, this contraction is cause for some concern, given the need for a sizeable increase in the housing stock in coming quarters.
Private consumption hits the brakes
One of the most important items in the national accounts is private consumption. Private consumption has been cantering along at a brisk pace ever since the first waves of the pandemic concluded early in the decade. In Q3/2023, however, it shrank by 1.7% in volume terms, the largest contraction since Q4/2020. Although various indicators had actually suggested that it would grow somewhat during the quarter, SI mentions in its press release that the 5% contraction in motor vehicle purchases was a major factor in the private consumption slowdown.
As with GDP growth itself, private consumption data show a sharp intrayear turnaround. The growth rate in Q1 was 4.5%, and in 2022 as a whole it was 8.5%. Leading indicators imply that a fairly hefty contraction is in the offing for Q4 as well. The Gallup Consumer Confidence Index, for instance, has sunk to its lowest value since early in the pandemic, and the October contraction in payment card turnover was the largest since the beginning of 2021. In the first three quarters of the year, private consumption growth measured 1.3%, whereas in the forecast published last week, the CBI projected it at 1.8% for the year as a whole.
Economy in a post-expansion adjustment phase
Taken together, SI’s newly published figures sketch quite a clear picture of a turnaround in the Icelandic economy. Not only is GDP growth slowing markedly, but it is becoming increasingly trade-driven as opposed to demand-driven.
In other words, the economy is moving towards better equilibrium after running quite hot in the past two years. This rebalancing is a sign that the economic policy responses of the CBI and the Government are coming ever more clearly to the fore. In our macroeconomic forecast from late September, we projected year-2023 output growth at 2.2%. The current figures line up well with that forecast, and it is mainly weaker import growth that could result in a stronger GDP growth rate than we have projected.
If developments continue in the current vein, the need for further monetary tightening from the CBI could prove less pressing in coming quarters than it would be otherwise. Last week, the CBI’s Monetary Policy Committee implied that there would have been grounds for a policy rate hike this month if the seismic unrest on the Reykjanes peninsula had not put a spanner in the works. But the newest figures indicate that turbulence has eased not only beneath the Earth’s surface but also above ground, where domestic economic activity seems to be tapering off steadily.