Labour supply ample; immigration down sharply

The Gallup survey of Iceland’s 400 largest firms also indicates reduced demand pressures in the labour market. At present, some 23% of executives consider their firms understaffed, a far smaller share than in the recent past. In Q3/2022, for instance, a record 56% of executives reported being short-staffed.  Labour shortages are apparently most pronounced in the construction sector, where 48% of executives say they need workers, and in miscellaneous specialised services, at 29%.

The recent decline in labour demand is probably the main reason for the marked slowdown in immigration to Iceland. In Q1/2025, net migration was positive by 190, the smallest number since Q1/2021. This is a major change from just a few years ago: for instance, in both Q2 and Q3/2022, immigrants outnumbered emigrants by more than 3,000, and on average, net migration has been positive by roughly 1,400 each quarter since 2021. According to data from Statistics Iceland (SI), the vast majority of immigrants are foreign nationals, as demand for labour has been especially keen over this period.

Wages set to rise most this year

The general wage index, published last week, rose by 1.8% month-on-month in April. The increase is due largely to contractual pay rises for public sector workers, plus a wage scale supplement, both of which took effect on 1 April. The year-on-year rise in the index now measures 8.2%, mainly because public sector pay rises were delayed in 2024, and the YoY increase includes two negotiated public sector pay hikes in the past twelve months. Wage inflation will ease as the year advances. In the aforementioned macroeconomic forecast, we assume that wages will rise by 7.7% YoY in 2025. Most of this increase has already come to the fore. In the past decade, wages have risen by an average of 7.5% per year.

Long-term wage agreements with the majority of the labour market have significantly reduced uncertainty. It is paradoxical that wages should rise so sharply at a time of vastly reduced tension in the labour market. This anomaly is due largely to last year’s contracts, which were signed in the midst of a very tight labour market. The situation will affect near-term wage developments, even though the slack in the market has widened.

Nevertheless, we are relatively optimistic about wage movements in the latter two years of the forecast horizon. We forecast that wages will rise by 5.0% per year in 2026 and 2027, somewhat below the average of the past decade. If this forecast materialises, real wage growth will measure just shy of 4% this year and 1.5% in both 2026 and 2027. Our forecast does not assume significant wage drift over the period, and risks to the forecast are tilted to the upside. If wages rise more than is depicted here, inflation is likely to be higher as well. We project that inflation will average 3.5% in both 2026 and 2027, thereby remaining above the Central Bank’s inflation target throughout the forecast horizon.