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Macroeconomic forecast 2023-2025: Adjustment phase ahead

Islandsbanki Research publishes a macroeconomic forecast for 2023-2025

After contracting sharply the Icelandic economy has recovered nicely and is showing signs of tension. We estimate that GDP growth measured 7% in 2022. Demand grew strongly and tourism regained its footing in 2022. We forecast GDP growth at 3.4% this year. Export growth will be a major contributor, supported by relatively robust growth in demand. We also project output growth at 3.4% in 2024 with private consumption and investment gaining pace while export growth slows. For 2025, the outlook is for GDP growth to slow to around 3%, owing mainly to weaker growth in exports.

The current account showed a sizeable deficit in 2022 and the outlook is for a moderate deficit this year, followed by a broadly balanced current account. An improving external balance is among the factors leading to an increasing probability of a stronger ISK further out the forecast horizon. We forecast that the ISK will be approximately 8% stronger at the end of the forecast horizon than at year-end 2022, equivalent to the EUR/ISK cross rate declining to around 142.

We believe that inflation has peaked in the beginning of the year and will subside over the forecast period as the housing market is calmer and import prices stabilize. Pressures in the labour market recede slowly and steadily and we predict an increase in purchasing power of wages this year. Persistent inflation calls for monetary restraint by the Central bank and the outlook is for a further 0.5% rise in the policy rate by the end of Q1. Gradual monetary easing will begin in late 2023.

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Main findings

  • GDP - 3.4% GDP growth both in 2023 and 2024. 2.4% GDP growth in 2025.

  • External trade - Current account deficit estimated 1.4% of GDP in 2023 but broadly in balance in 2024 and 2025.

  • Inflation- Inflation peaked in January 2023 and will now subside. To average 7.6% in 2023, 4.5% in 2024 and 2.8% in 2025.

  • Labour market - Unemployment to average at 3.3% in 2023, 3.7% in 2024 and 3.8% in 2025.

  • Interest rates - Policy rate projected at 6.5% by the end of Q1 2023. Gradual monetary easing to begin on the late 2023.

  • The ISK - ISK estimated to be 8% stronger at the end of the forecast horizon than at end-2022.

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Jon Bjarki Bentsson

Chief economist


Bergthora Baldursdottir