Is the labour market cooling?

The labour market is calming down, and unemployment has inched upwards recently. Unemployment is expected to rise farther next month because of the fall of airline Play. The overall impact of the company’s failure will probably be limited, however. The outlook is for a more tranquil labour market in the coming term, with smaller pay rises than in recent years, unless wage drift sets in.

There has been discourse recently about an incipient slack in the labour market after the overheating of the past few years. Last year, most indicators – such as immigration and labour shortages in Iceland’s largest companies – suggested that the market had softened, although jobless rates did not indicate a cooling market until early in 2025, when registered unemployment rose above 4% for the first time in three years.

How much impact will Play’s collapse have on the labour market?

Registered unemployment measured 3.5% in September, according to recent figures from the Directorate of Labour (DoL). Unemployment fluctuates with the seasons and is generally highest at the start of the year and in the second half. It has averaged 3.8% in 2025 to date. It is expected to creep upwards in October, in the wake of Play’s declaration of insolvency at the end of September. About 420 company employees and another 55 airport workers who provided service to Play lost their jobs. If all of them are added to the unemployment rolls, the number of jobless persons will rise to 8,320, and the unemployment rate will be around 3.7%. Some of these workers will probably find other jobs quickly, however, or will enrol in a course of study. The DoL forecasts that unemployment will be 3.6-3.7% in October, driven by Play’s collapse and seasonal factors.

Play had significantly scaled down its operations prior to its failure. For instance, it had discontinued all flights to the US and was concentrating instead on trips to warm-weather holiday destinations in Europe. Because of this, the impact on the labour market will be limited, and far less pronounced than when WOW Air failed in 2019, causing 1,100 people to lose their jobs and pushing unemployment up from 3.2% to 3.7%. WOW was a larger airline than Play, with a bigger market share and more extensive operations.

In our recent macroeconomic forecast, published before Play failed, we projected that unemployment would average 3.8% this year. After the events of recent weeks, it is more likely to be close to 4%.

Indicators of a cooling labour market

Immigration is probably one of the best barometers of the labour market situation. When the market was tightest, about 2,000-3,000 individuals moved to Iceland each quarter. The influx started to slow significantly in late 2024 and has continued to lose pace in 2025. In H1/2025, for instance, 1,500 individuals moved to the country, 37% fewer than in H1/2024 and 60% fewer than in H1/2023.

Another reliable indicator of the status of the labour market is Gallup’s corporate survey of Iceland’s 400 largest firms. That survey shows that only 21% of executives consider their companies short-staffed, the lowest rate reported since Q1/2021. In mid-2022, when the labour shortage was most acute, 56% of executives considered their firms understaffed. Interestingly, the shortage of workers appears to be most pronounced by far in the construction sector, where 41% of firms report being short-staffed. In other sectors, the same ratio ranges between 5% and 27%.

Inflation below the benchmark: stability agreement holds

Long-term wage agreements were signed in 2024, when the market was still quite tight. This will affect wage developments in coming years despite the increased slack in the labour market. Long-term wage agreements significantly mitigated uncertainty, however. The stability agreement, which applies to around 70% of private sector workers, remains in effect from February 2024 through January 2028. It provides for pay hikes of 3.25-3.5% per year, or a minimum of ISK 23,750. In addition to these are any wage scale supplements or productivity increases that may apply. A wage scale supplement has already been paid out, on 1 April 2025, boosting minimum pay scales by 0.58%.

Public sector employees negotiated comparable pay hikes, plus a wage table supplement that took effect on 1 September. In addition, the public sector labour federations BHM and BSRB increased the rates on their wage tables by 0.75-1.24%.

The assumptions clause in the stability agreement is based on an inflation benchmark. The contract may be subject to revision if twelve-month inflation as measured in August exceeds 4.95%, or if annualised inflation for the period from March through August exceeds 4.7%.

This August, twelve-month inflation measured 3.8% and was therefore well below the stated benchmark. The next potential revision could occur on 1 September 2026, if twelve-month inflation exceeds 4.7% that August or if annualised inflation for the period from March through August exceeds 4.4%. According to our forecast, inflation will be quite a bit below these levels, or 3.8% in August 2026.

Moderate pay rises ahead

The general wage index has risen by 7.7% over the past twelve months, and while this looks like a hefty increase at first glance, it is only marginally above the past decade’s average rise of 7.6% per year. Wages are assumed to increase by 7.8% this year, but much of this has already materialised. Most contractual pay hikes have already taken effect, as have private sector pay scale increases and public sector wage table supplements.

In our new macroeconomic forecast, we projected that wages would rise by 5.4% in 2026 and 5.3% in 2027. If this forecast holds, pay hikes will be somewhat below the recent average and can therefore be called moderate. If there is significant wage drift during the period, however, wages could rise more than is assumed in the forecast. Real wages, which have held their ground despite high inflation, will grow the most this year and then increase more modestly in 2026 and 2027.

Author

Bergthora Baldursdottir

Economist

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