The Icelandic economy has picked up strongly after a steep contraction in the wake of the pandemic. Output growth measured 6.4% in 2022, its strongest since 2007. ÍSB Research forecasts year-2023 GDP growth at 3.1%, which is broadly in line with our last forecast. Export growth will be the main driver of output growth this year, and the contribution from domestic demand will be much smaller than in 2021 and 2022. We project GDP growth at 2.4% in 2024 and 2.8% in 2025.
The outlook is for the current account balance to improve over the course of the forecast horizon, after a sizeable deficit in recent years. A more favourable current account balance and other factors enhance the likelihood that the ISK will appreciate further ahead. According to our forecast, the ISK will be approximately 8% stronger at the end of the forecast horizon than it was at the beginning of 2023.
Inflation has proven stubborn but will give way during the forecast horizon, owing in particular to a more tranquil housing market and greater price stability abroad. Demand pressures in the labour market will subside gradually, and real wages will start rising again in 2024. Persistent inflation will call for a tight monetary stance, with the policy rate set to peak at 9.5% later this year. A gradual monetary easing phase could begin early in 2024.