The outlook for the British economy is extremely cloudy at present. Skyrocketing energy prices and various other factors have pushed inflation sharply upwards, as in most of Iceland’s neighbouring countries. According to the Bank of England’s (BoE) most recent forecast, released in August, inflation is projected to peak at just over 13% in Q4/2022 and remain high throughout 2023. Various financial analysts are even more pessimistic about the UK inflation outlook, however, led by Goldman Sachs, which forecasts that inflation could top 20% in the UK if energy prices keep rising.
How might an economic setback in the UK affect Iceland?
If the UK suffers a serious economic slump this winter, it could have a marked impact on Iceland’s exports in the quarters to come. As yet, however, there are no signs that the worsening economic outlook for Great Britain will affect demand for travel to Iceland or for Icelandic marine products.
The BoE also forecasts a contraction of just over 2% in the UK economy from Q3/2022 until Q3/2023. The contraction will be caused not least by a marked erosion of real disposable incomes in the UK, with high inflation more than eating up nominal wage rises. In addition, the outlook is for a steady increase in unemployment, although the employment situation in the UK is currently good, as it is in Iceland. Furthermore, a wave of strikes is sweeping the country, which is also battling a sizeable current account deficit and a hefty fiscal deficit, although the latter is due largely to pandemic response measures, as is the case in many countries. The British authorities are preparing measures to protect the general public from the most painful effects of high energy prices, but presumably these measures will be debt-financed, thereby adding to the UK’s already sizeable pile of public debt.
Why does an economic downturn in the UK matter for Iceland?
The UK is one of Iceland’s most important trading partners; therefore, a severe economic setback there could have a strong impact on the economic outlook for Iceland. To be sure, many economies are facing stormy weather, particularly in mainland Europe, but also west of the Atlantic. Yet the UK has a special place among Iceland’s trading partners, and it is therefore useful to examine the impact that a demand shock stemming from British households and businesses could potentially have on the Icelandic economy.
In recent years, the British have been among the largest groups of visitors to Iceland. In 2022 to date, the UK accounts for 14% of tourist arrivals, second only to the US. Before the pandemic, British travellers accounted for an even larger share, or 15.5%. On top of this, the British have been extremely willing to visit Iceland outside the peak season. During the pre-pandemic period, about three-fourths of all British nationals’ trips to Iceland took place during the off-peak season, and more often than not, the British were the best-represented nationality among winter visitors.
After a buoyant late-summer season, it is very important for the sector that the stream of tourists this coming winter should also be steady and strong, as many tourism companies are repairing their balance sheets and reviving their operations after two very lean years during the pandemic. As a consequence, it could be a blow to the sector if few visitors from the UK come to Iceland this winter. In this context, it should also be remembered that the Chinese, who accounted for an important share of wintertime tourism during the pre-pandemic period, have been little in evidence since then, as they are still subject to tight restrictions on overseas travel.
The UK is also an important buyer of Icelandic exports, particularly marine products, accounting for some 16-17% of total fishing industry export revenues in recent years. In 2021, goods exports to the UK amounted to ISK 56bn, including ISK 45bn deriving from marine products. No other country bought marine products from Iceland for a larger amount that year. Presumably, Icelandic exporters will find other buyers sooner or later if the British cut back significantly on their purchases, but it could take time, and the price would probably be quite a bit lower – for a while, at least.
In 2019, the last full year before the pandemic struck, Iceland’s goods and services exports to the UK totalled ISK 150bn, or 11% of total exports for the year.
Clearly, then, it could pose a real challenge if demand for travel to Iceland and for Icelandic marine products and other exported goods and services shrinks significantly over the coming winter because of reduced household purchasing power in the UK. Fortunately, there are still few signs, if any, that this situation is materialising, according to a recent interview with the Director General of the Icelandic Tourist Board, although the possibility that such a scenario will develop later this autumn cannot be excluded.
As is mentioned above, the economic outlook is ambiguous in more countries than just the UK. For a small open economy like Iceland, key trading partners’ economic health is very important. One can take some comfort, however, in the general expectation that inflation will ease and the global economy will firm up further ahead. It is wise to be prepared for blustery headwinds in various export sectors over the coming winter, but hopefully developments worldwide will prove more favourable than is depicted in the bleakest forecasts.