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GDP on the rise again

GDP growth was robust in H1/2021, thanks for the most part to handsome growth in private consumption and investment. The contraction in residential investment and unfavourable developments in external trade give some cause for concern, however. Growth in domestic demand may end up weighing heavier than the recovery of tourism in this year’s output growth, in defiance of expectations.

The post-COVID economic recovery firmed up nicely in Q2/2021, according to newly published national accounts figures from Statistics Iceland (SI). In fact, the quarter saw the first positive output growth numbers since Q4/2019. The economy grew in real terms by 7.3% year-on-year, owing for the most part to growing private consumption and investment. Private consumption grew by 8.5% during the quarter, the fastest growth rate thus measured in nearly four years. In addition, total investment grew by nearly 26%. Growth in national expenditure, which reflects domestic demand, measured 9.4% YoY. Actually, exports grew as well during the quarter, by almost 28%, but they were outpaced by import growth, which measured 33%, leaving a negative contribution from net trade to output growth.

Iceland’s quarterly national accounts are extremely volatile; therefore, we think it more useful to examine the first half of the year, although the two quarters certainly differed from one another and were affected by developments in the pandemic.

The economic recovery gained a foothold in H1

GDP growth measured 3.5% in H1/2021, thanks for the most part to 4.7% growth in private consumption and over 13% growth in investment. But the contribution from net trade was negative in H1: export growth measured only 1.6% and was dwarfed by goods and services imports, which grew by 8.2%. To a large extent, the surge in imports is linked to private consumption and investment. For instance, household motor vehicle purchases rose by a staggering 72% YoY in H1. In addition to this, investment in ships, aircraft, and the like nearly quadrupled YoY in Q2, and almost all of this investment shows in corresponding imports.

Developments in goods trade versus services trade diverged in H1. On the goods side, there was robust growth in both imports and exports, whereas services imports and exports contracted during the period. In the main, the services items reflect how strongly the pandemic affected cross-border travel until mid-year. A turnaround is expected in H2, however, as travel has been on the rise since the beginning of July.

Investment takes flight

Investment has accelerated to a brisk pace this year, after a two-year contraction. Business investment in particular has surged: in H1, it grew by nearly 22% YoY, far more than we had anticipated. The aforementioned spike in purchases of large transport equipment was a major factor in that surge, but even excluding ships and aircraft, business investment still grew by almost 16%. Furthermore, public investment grew by just over 14% YoY in H1,

although the same cannot be said of residential investment, which contracted by 6.7% YoY during the half. This trend gives real cause for concern, as the housing market has been characterised by a shortage of new flats for sale, which has pushed prices upwards. It seems as though this situation will take quite some time to right itself.

Continued GDP growth in the offing

On the whole, it can be said that domestic demand is rebounding more decisively than we had expected, but that developments in external trade are less favourable than we had assumed. In our macroeconomic forecast from May, we projected year-2021 GDP growth at 2.7%, driven mainly by export growth plus a modest increase in private consumption and investment. If this situation continues as is, though, the calculus could be upended and growth driven by domestic demand instead of exports. As before, the outlook is for GDP to continue growing in H2, and therefore in 2021 as a whole. But this depends to a large degree on whether private consumption and investment remain strong and how quickly the unfavourable trade situation turns around.


Jón Bjarki Bentsson

Chief economist