Real wage growth set to lose steam

Real wage growth has eased in recent quarters, although Icelandic households have benefited from stronger growth in the recent past than those in neighbouring countries.

Real wage growth has eased in recent quarters, although Icelandic households have benefited from stronger growth in the recent past than those in neighbouring countries. The newly landed wage agreements will also boost purchasing power in the quarters to come. Modest real wage growth and relatively slow population growth will probably cause private consumption to rise less in 2019 than in the past few years, as Icelandic households currently appear unwilling to finance spending growth with credit.

Weaker growth in wages and purchasing power

The Statistics Iceland (SI) wage index rose by 0.2% in March and has risen by 5.5% in the past twelve months. The pace of the increase has eased gradually in recent months, as wage agreements for large segments of the work force expired at the turn of the year and re- negotiations proved lengthy.

Given that the CPI jumped 0.5% in March, the above-mentioned rise in the wage index translates to a 0.3% drop in real wages for the month. However, real wages as measured by the wage index have grown 2.5% in the past twelve months.

Real wage growth has slowed considerably in the recent past, after surging from around the middle of the decade and peaking in 2016 at 9.5% year-on-year. This unusually swift growth was due to a combination of factors, with large pay hikes coinciding with low inflation caused mainly by the appreciation of the ISK. In 2018, however, real wage growth averaged only 3.7%, owing to smaller nominal pay rises and higher inflation than in the years beforehand.

This reflects the front-loaded wage agreements made in the middle of the decade and differences in exchange rate pass-through to domestic inflation. It can be said, then, that much of the scope for real wage growth that developed during the boom of the mid-2010s was used up sooner rather than later. Even so, a real wage growth rate of “only” 3.7% is quite strong in international context.

Purchasing power and private consumption go hand-in-hand

Developments in purchasing power are one of the wellsprings of private consumption in Iceland. Just over a decade ago, the link between the two weakened noticeably because households relied heavily on credit to finance consumption spending. This has not been the case in recent years, however, as can be seen in the reasonably close correlation between real wage growth and private consumption, as well as in the good news that households have scaled down their debt during the current business cycle.

The wage agreements recently finalised for a large share of private sector workers have now been approved by union members as well as employers. This means wages for the groups affected with rise significantly from April onwards. Agreements are still pending for various groups of tradesmen and public sector employees, but we hope the parties concerned will negotiate contracts broadly similar to those already approved by employees. But there are no guarantees, as contracts based on fixed rather than proportional increases tend to be less attractive to employees further up the pay scale.

Outlook for weak private consumption growth in 2019

In our most recent inflation forecast, we project that wages will be, on average, 5.2% higher this year than in 2018 and that prices will be 3.3% higher. If those assumptions are borne out, real wage growth will measure 1.8% in 2019. This is weaker growth than Icelanders have seen in the past five years, although many workers in neighbouring countries would welcome such a rise in purchasing power. If population growth turns out weaker this year, as SI has projected, private consumption growth will probably lose momentum.


Jón Bjarki Bentsson

Chief economist