What has drawn our attention – and doubtless that of other observers – is now little the conflict in the Persian Gulf has affected the ISK exchange rate. For example, the ISK is unchanged against the euro since end-February, when the hostilities in the Gulf began, although it has weakened slightly against both the US dollar (-1.7%) and the pound sterling (-1.2%) over the same period. On the other hand, it has strengthened a bit against two of its Nordic neighbours, the SEK (1.1%) and the NOK (0.8%).

It is noteworthy that the ISK should hold its ground so well against the currency of an oil exporter like Norway. The explanation could be that even though Norway should presumably benefit from higher oil prices, concerns about GDP growth in Europe and a war-induced wave of risk aversion could pull in the opposite direction. In any event, the Canadian dollar, another currency from an oil and commodity exporter in our neighbourhood, has developed very differently, tracking the US dollar for the most part, as the chart indicates. The CAD has tended to align more closely with the dollar than the NOK has, as the US’ financial and trade-related importance to Canada stems from far more than commodity prices alone.

On the whole, these exchange rate movements are modest, given the whiplash in the energy, commodity, and securities markets since the outbreak of hostilities at the end of February. Historically, the ISK has been far more volatile during periods of global turmoil, which generally give rise to greater risk aversion and an abrupt reallocation of capital.

The developments above primarily indicate the short-term resilience of the ISK, however. In the long run, underlying developments in the real exchange rate, costs, and competitive position will carry greater weight.

Substantial indirect holdings in foreign corporate giants

As usual, the CBI’s newly published Financial Stability report contains a wealth of interesting information about Iceland’s external conditions and foreign exchange market. The report points out, as we have often done ourselves, how important Iceland’s ample net asset position is for financial stability. The CBI’s presentation of the composition of external assets and liabilities caught our eye, as it shows clearly how heavily the pension funds’ foreign assets weigh in the overall position.

In this context, it is worth stressing that the lion’s share of the pension funds’ foreign assets take the form of holdings in international UCITS funds. For the most part, these holdings in turn represent shares in global equities, not least in companies listed on the US stock market, the largest in the world, with 60% of the total market value of listed equities worldwide. The CBI discusses this in the Financial Stability report, noting that it could pose a risk in the event of a price correction west of the Atlantic.

There has been much discourse recently about how Icelanders are not successful enough at holding on to domestic tech and innovation companies, and commentators point out examples involving recent acquisitions by foreign companies or, in some cases, Icelandic firms’ voluntary offshoring of their activities. We agree wholeheartedly that it is vital to pay attention to operating conditions and competitive position in the Icelandic tech and innovation sector. But it is well to remember also that through the pension system, Icelanders own sizeable holdings in the global tech sector, even though those holdings are more dispersed and less visible.

Will the interest rate differential attract non-residents?

The CBI also published updated figures showing a range of interesting FX market variables. For instance, developments in the commercial banks’ forward currency swap agreements provide interesting insight into customers’ position-taking for hedging or speculation.

The banks’ net forward FX position, in which Icelandic krónur are specified in a contract against foreign currency, began to grow last autumn, after a steady decline dating back to mid-2024. In the CBI’s assessment, this indicates an increase in domestic firms’ and investors’ desire to use derivatives protect themselves against a possible ISK appreciation, not least in the wake of the sudden depreciation last October.

In part, the CBI attributes the early-2024 contraction in the forward FX position to a reduction in Icelanders’ use of derivatives, while foreign financial institutions have stepped up their direct and indirect participation in currency swaps with the commercial banks in the recent term. The banks’ net forward FX position totalled ISK 133bn at the end of February, an increase of over ISK 40bn since end-August 2025.

The CBI points out correctly that the interest rate differential with abroad could exacerbate the risk of volatility in FX flows and the ISK exchange rate if it prompts a strong shift towards highly liquid short-term ISK assets. We Icelanders need only look back to the 2000s for a memorable example of this risk. Fortunately, though, it is no longer possible to use derivatives for foreign position-taking in the ISK to the degree that we saw before the 2008 financial crisis, as the CBI’s rules place strict limits on such trading.

At the same time, foreign inflows into the domestic securities market have been modest overall in the recent term, although non-residents’ holdings have fluctuated fairly widely from one quarter to another. The CBI notes that non-residents’ holdings in Icelandic Government bonds were unchanged year-on-year at the end of 2025, although there was significant trading within the year. The same is true of their investment in listed equities. Over the first two months of 2026, however, foreign investors’ holdings in Government bonds have grown, while their shareholdings have shrunk accordingly.

Pension funds scaling up FX purchases again

There has been much talk about the temporary lull in the pension funds’ FX purchases, which came after they received sizeable sums in foreign currency upon the settlement of ÍL Fund and JBT’s acquisition of Marel last winter. In all, the funds bought about ISK 54bn in foreign currency last year, about half of their average for each of the years beforehand.

The CBI points out that this dip in the funds’ FX purchases strongly affected the ISK exchange rate in 2025, presumably supporting it. On the other hand, the pension funds stepped up the pace in the last four months of 2025, and their FX purchases in the early months of 2026 have also been broadly in line with the pre-2025 pattern. The CBI mentions that in general, the pension funds are planning to increase the weight of FX assets in their portfolios this year. We can therefore expect them to remain big buyers of currency in the domestic market.

Is the stronger ISK merely a brief respite?

In our macroeconomic forecast from end-January, we projected that the ISK would weaken marginally in each year of the forecast horizon. Our forecast assumed that the EURISK exchange rate (the price of one euro in ISK) would average 149 in 2026, 152 in 2027, and 156 in 2028. For comparison, the EURISK exchange rate was 145 in 2025 and has averaged 145.1 in 2026 to date.

Since we published our forecast, the outlook for exports have improved somewhat, whether for tourism, the fishing industry, or metals manufacture. In addition, the interest rate differential with abroad will probably be wider in the near future than we expected in late January, owing to the bleaker inflation outlook and its impact on Iceland’s policy interest rate. As a result, the ISK may well turn out stronger in the near term than we envisioned in January.

But we expect it to sag over time, unless wages and prices in Iceland become better aligned with those in neighbouring countries than they have been in recent years and decades. At present, the real exchange rate is at the upper end of the range we consider consistent with a reasonably good external balance, and all else being equal, it will rise slowly and steadily due to robust wage growth and persistent inflation. If the nominal exchange rate does not fall, Iceland’s competitive position will be gradually eroded, the current account deficit will widen, and the correction via the depreciation of the ISK will be accordingly more abrupt.