ISK stable despite shocks

This exchange rate stability has characterised the Icelandic economy ever since it began to right itself during the later stages of the pandemic. Since the beginning of 2023, the ISK’s underlying trend has been towards a gradual appreciation, albeit with some brief fluctuations in the interim. We find this stability noteworthy, given the turmoil in the domestic and global economies over this period.

Events on the international front include Russia’s full-scale invasion of Ukraine in early 2022 and the war that has raged ever since, the tariff war waged by the US on most of its key trading partners since April 2025, and the on-again-off-again war in the Persian Gulf, which has juddered commodity markets and the global financial market.

The domestic scene has been dominated by the earthquakes and volcanic eruptions on Reykjanes peninsula and their wide-ranging impact on the economy, a series of shocks hitting Iceland’s goods export sector in H2/2025, and the collapse of airline Play that autumn.

Nor can this remarkably steady exchange rate be attributed to an unusually well balanced current account – at least, not at first glance. Iceland has been running a sizeable current account deficit in the recent past, with a historically large deficit on goods trade more than offsetting the handsome services account surplus. But if we take a peek under the hood, we can see that trade-related FX flows have been considerably more favourable than they might appear at first perusal. This is due largely to booming investment in data centres and the associated surge in imports of computer equipment and the like, which are financed abroad by the companies’ owners and customers. All of this has tended to stimulate FX inflows, as the companies have needed to sell foreign currency to pay wages, purchase services, and cover public levies.

In addition, the price of Iceland’s main goods exports has been high recently, providing a bit of a cushion against the above-mentioned export shocks and the spike in fuel and commodity prices due to the Persian Gulf war.

Who has been buying the ISK?

It is interesting to look at developments in the commercial banks’ forward FX contracts, as these reflect positions taken by the banks’ customers. In the past five years, the position has always been positive, indicating that the banks’ customers have usually held positive forward positions in the ISK.

The net FX position declined considerably, however, from spring 2024 through spring 2025, bottoming out at ISK 87bn at the end of March 2025. Since then, it has ballooned again, reaching ISK 154bn at the end of May 2026. The CBI has pointed out that the composition of the group of investors holding forward FX contracts with the banks has changed somewhat. Foreign financial institutions have grown more prominent among the banks’ counterparties, buying about ISK 100bn in 2025, according to the CBI’s Financial Stability report. In that report, the CBI stresses that the interest rate differential with abroad creates an incentive to invest in volatile ISK assets, which could result in sudden outflows and downward pressure on the exchange rate if investors should change their minds. Nevertheless, the CBI emphasises that its rules on foreign exchange balance and derivatives trading set much firmer boundaries on such position-taking than they did prior to the financial crisis.

Some of the ISK’s stability in the recent past stems from the pension funds’ unusually limited FX purchases over the period, particularly in 2025. The funds bought FX for only ISK 54bn in 2025, down from ISK 80-120bn in the years beforehand. In the above-cited Financial Stability report, the CBI notes that pension funds’ demand for currency over this period was dampened both by unrest in global securities markets and by the foreign currency payments they received upon JBT’s takeover of Marel and the settlement of ÍL Fund.

The same can be said about the CBI’s FX market intervention programme, rebooted in May after a five-month hiatus. Since mid-May, the CBI has bought euros for nearly ISK 11bn under its regular purchase programme. According to its press release on the subject, the bank plans to continue in this vein until mid-October, bringing its total purchases to ISK 20bn. In comparison, the CBI’s total EUR purchases in 2025, in both regular intervention programmes and ad hoc transactions, came to ISK 68bn. The bank’s declared objective with the regular purchases is to keep its international reserves above specified benchmark levels. We suspect, however, that the relative strength of the ISK has done little to deter the bank from buying currency; in fact, CBI officials have commented publicly on it.

Strong today, but what about tomorrow?

As we have noted, the ISK has been both strong and stable in spite of the headwinds described above. Earlier this year, we discussed fluctuations in the ISK as compared with other currencies, and we concluded that ISK exchange rate movements have had a countercyclical effect in recent years. The benefits of a floating currency have therefore increased and the costs have fallen. Both the CBI and the International Monetary Fund (IMF) have expressed similar views in the recent term. But what lies behind the solidity of the ISK?

In sum, we think it likely that the following factors, when taken together, explain the developments seen in recent quarters:

• Foreign capital for investment in data centres and infrastructure development has generated FX inflows to cover the cost of domestic services, wages, and public levies.
• The price of Iceland’s main goods exports has been high, supporting FX revenues and counterbalancing rising commodity and fuel prices.
• Demand for the ISK has grown, owing to the interest rate differential with abroad, as can be seen in a growing net forward FX position and the greater weight of foreign financial institutions in the market.
• The strengthening of the net forward ISK position in 2026 indicates two things: resident entities’ desire to protect their future FX revenues against an ISK appreciation, and market agents’ willingness to maintain or increase their exposure to the ISK in spite of external uncertainty.
• Domestic entities have increased their foreign borrowing, both to finance various infrastructure projects and to avail themselves of more favourable borrowing terms in foreign markets.
• And last but not least, there is little doubt that Iceland’s strong net international investment position (NIIP) and ample international reserves have boosted confidence in the domestic economy for the long pull, allaying investors’ concerns that sudden capital flight could call forth a currency crisis and cause the ISK to implode. These effects can be seen in many of the factors discussed above.

In our macroeconomic forecast from early June, we discussed the exchange rate outlook for the years ahead. As is noted above, the ISK is buoyed up by a number of factors at present, including Iceland’s strong NIIP, sizeable international reserves, robust economic foundations, and continued interest rate differential with abroad. On the other hand, the ISK could hit a few speed bumps if tourism turns out weaker than expected, if inflows of foreign capital subside markedly, or if terms of trade worsen.

Furthermore, the real exchange rate is historically high, although it could be argued that the economy’s tolerance for a high real exchange rate has grown (or the equilibrium real exchange rate has risen), if Iceland’s relatively modest underlying current account deficit in recent years is any indication. Even so, given that wages and prices rise faster in Iceland than in trading partner countries, the nominal exchange rate can be expected to ease over time.

Our exchange rate forecast assumes a gradual depreciation rather than an abrupt correction. According to that forecast, the ISK will be an average of 5% weaker at the end of the forecast horizon than it was at year-end 2025. A euro would therefore cost about ISK 153 and a US dollar about ISK 132, based on those currencies’ end-2025 exchange rates. As is always the case, however, the exchange rate outlook is highly uncertain, and the experience of recent decades has taught us that unforeseen plot twists can often have a strong short- or medium-term impact on the ISK.