This pattern has more or less continued in H1/2025. The current account has shown a large deficit year-to-date, as we have discussed recently. That notwithstanding, the ISK appreciated by nearly 3% in trade-weighted terms from the start of the year through mid-June. It has strengthened to varying degrees against individual currencies, however. For instance, in mid-June it was virtually the same against the euro, Iceland’s largest trading partner currency, as it was at the turn of the year. Over the same period, though, it appreciated by 2.6% against the pound sterling and more than 12% against the US dollar.

The difference reflects the past few quarters’ wide fluctuations between the euro and the dollar, the world’s leading currencies, with the cross exchange rate between the two rising from EUR 1.027 per dollar to EUR 1.155 per dollar. This represents a nearly 13% appreciation of the euro against the dollar. Comparable movements have been seen between the dollar and other key currencies, mainly reflecting the weakening of the dollar worldwide. The depreciation of the dollar is due in part to a changed economic outlook for the US, heightened uncertainty about the safety of US Treasury bonds as assets, and concerns about the US administration’s erratic policy on tariffs.

ISK strengthens despite current account deficit

But what lies behind the overall strengthening of the ISK at a time when the current account deficit has been so large? The most succinct answer is that the deficit has been fully financed, either directly with foreign currency or through FX inflows for investment and lending in Iceland.

For instance, a large share of the past few quarters’ deficit derives from large-scale importation of investment inputs. For the first five months of 2025, the value of these imports (excluding transport equipment) was about 67% higher in ISK terms than over the same period in 2024. This is due not least to development in the data centre sector. As Statistics Iceland noted in a recent press release, “The large growth in capital goods can mostly be attributed to the large-scale imports of computer projects by companies that run data centers in the country.” The data centres are foreign-owned, and development in the sector has been financed in foreign currency. Such large-scale development could even generate some FX inflows, as labour and services contributed by domestic parties must be paid for in ISK.

Furthermore, there were sizeable FX inflows associated with the merger between Marel and US company JBT, which was settled at the beginning of 2025. As a rough estimate, it can be assumed that as a result of the settlement, Icelandic pension funds received FX payments equivalent to perhaps ISK 50bn. Moreover, on 12 June, the pension funds received the equivalent of just over ISK 50bn in foreign currency in connection with the settlement of Housing Financing Fund (HFF) bonds.

These inflows are doubtless one of the main reasons the pension funds’ FX purchases have been so modest recently. According to the CBI’s recently published Monetary Bulletin, the pension funds bought foreign currency for a net total of just under ISK 11bn in the first four months of 2025, or an average of ISK 2.7bn per month. In comparison, their net purchases averaged around ISK 7bn per month in both 2023 and 2024. Their FX purchases will probably remain moderate in coming months, owing to the HFF bond settlement, but the pension funds have long played a key role in investing a portion of Icelanders’ long-term savings abroad, thereby curbing the appreciation of the ISK.

CBI shoring up its reserves

The pension funds’ limited FX purchases probably play a role in the CBI’s decision to reinstate a regular currency purchase programme this past April. The CBI’s participation in the FX market has been minimal since spring 2021, when it discontinued the regular currency sales programme launched during the pandemic in response to reduced FX revenues from the tourism industry. Nevertheless, the bank has intervened in the market when one-off transactions have caused severe temporary imbalances in FX flows. The last time a regular FX purchase programme was in place was in H1/2017.

In its press release, the CBI states the following (our emphasis):

The main objectives of the currency purchase programme introduced now are to increase the share of reserves financed in Icelandic krónur and to meet the Treasury’s need for currency. Sizeable reserves have played an important role in maintaining stability and resilience against shocks. The outlook is for the reserves to shrink marginally in the coming term, all else being equal, owing to foreign payments made by the Bank on the Treasury’s behalf. Furthermore, the Bank is of the opinion that conditions are now favourable for expanding the programme and that the purchases will not materially affect the exchange rate of the króna.

This assessment by the CBI was sound, given developments in the exchange rate since then, and to some extent, its purchases have prevented the ISK from appreciating more strongly year-to-date than it actually has. When the purchase programme was announced, the CBI began buying EUR 6m per week.

From April until mid-June, it bought a currency for a total of ISK 7bn. Then, on 12 June, the bank announced that it would double its weekly purchases from EUR 6bn to EUR 12bn. Based on the current EURISK exchange rate, this equals just under ISK 7bn per month, about the same as the pension funds’ average monthly purchases in 2023-2024.

ISK buoyed by tailwinds at present, but a modest depreciation is likely further ahead

The outlook is for a relatively strong ISK in the immediate future. The peak tourist season lies ahead, and forward FX positions are limited, suggesting that a large share of the summer’s FX revenues will be converted to ISK. According to CBI data, the commercial banks’ net forward FX position totalled ISK 104bn at the end of April, as opposed to ISK 161bn at the same time in 2024 and just under ISK 175bn as of end-April 2023. The banks’ net forward FX position reflects the amount of currency their customers have agreed to sell at a predetermined exchange rate in the months ahead.

Inflows for securities purchases and other investments are likely to continue, and as is noted above, the pension funds will probably buy relatively modest amounts of currency in the near term.

On the other hand, there appears to be scant further scope for appreciation without adverse effects on external trade, one sign of which is a persistent CA deficit. It should be borne in mind, however, that as is noted above, the recent CA deficit is due in fairly large part to strong investment, not least in export sectors. Because of this, the deficit is less worrisome than it might be otherwise, and in fact, we expect the current account to move towards a better balance starting in 2026.

Even so, the fact that the real exchange rate is close to its historical peak cannot be ignored. The real exchange rate reflects how “expensive” Iceland is in international context – or, in other words, how competitive the local economy is when adjusted for relative wages and prices. Although the economy can probably tolerate a higher real exchange rate than before without external imbalances, at least for the present, there are limits to how costly Iceland can be relative to other countries before export sectors and the external balance of the economy start to suffer from the high exchange rate.

As the forecast horizon progresses, we expect the ISK to retreat from its current level. We forecast the EURISK exchange rate at close to 144 by the end of 2025, roughly 147 by end-2026, and about 150 by the end of the period. This translates to a depreciation of around 4% from the current rate. Short-term fluctuations will probably weigh in as well, as they have done to date, although exchange rate volatility has subsided markedly in the recent term.