The ISK held relatively stable in 2024, despite a current account deficit. Even though there were some short-term fluctuations in H2, the exchange rate was largely the same in 2024 as in 2023. For example, the average trade-weighted exchange rate index was virtually the same (195.23) in 2024 as in 2023 (195.17). The same can be said of the euro and the US dollar, although the relative exchange rate of these two currencies, the largest in the world by their share in world trade, has changed markedly during the period.
Will the ISK continue to hold steady?
Despite some short-term fluctuations, the ISK exchange rate has been remarkably stable in the recent term. The outlook is for continued stability in the quarters to come. A rising real exchange rate makes a depreciation more likely further ahead, however.
The ISK strengthened markedly from early September until the year-end, in spite of Iceland’s Q4 trade deficit. As we have discussed previously, capital inflows for securities investments, changed expectations, and modest investment-related outflows are probably the most important factors in this ISK appreciation. On the other hand, position-taking with the ISK does not seem to have increased early in the appreciation phase; on the contrary, the banks’ customers continued to scale down their net forward positions with the ISK, at least until end-November.
The Central Bank’s (CBI) newly published summary of Iceland’s foreign exchange market, exchange rate movements, and international reserves in 2024 includes a discussion of developments during the year. Among other things, it is pointed out that the CBI intervened in the foreign exchange market only once during the year, and that this happened concurrent with non-residents’ large-scale purchases of ISK-denominated Treasury bonds in Government Debt Management’s February auction.
Relatively stable exchange rate on the horizon in the near future
Our recently published macroeconomic forecast includes a discussion of probable exchange rate developments. In that forecast, it is pointed out, among other things, that the outlook is for the current account to be broadly in balance over the forecast horizon, which extends through year-end 2027. FX flows due to goods and services trade or other CA subcomponents will probably not be the main determinants of the exchange rate, although they could certainly cause short-term fluctuations.
Other contributing factors will probably offset each other from one period to another in the FX market. For instance, foreign investors will probably remain interested in direct or indirect investments in large and small Icelandic companies, as well as in bonds. A continuing interest rate differential with abroad should also encourage them. Such inflows would then counteract foreign investment by the pension funds and other resident investors. Actually, the recent settlement of US company JBT’s acquisition of Marel could somewhat curtail the pension funds’ FX purchases in the near future, as the funds now hold more foreign assets, both in the form of JBT shares and in foreign-denominated cash, as a result of the transaction.
The real exchange rate is high
Although the nominal exchange rate is still well below its peak from the mid-2010s, the real exchange rate has risen steadily, as prices and wages have risen faster in Iceland than in trading partner countries. By that measure, the ISK is probably approaching the upper end of the range consistent with a satisfactorily balanced current account. As a result, any large additional appreciation will ultimately erode exporters’ competitive position vis-à-vis comparable sectors in other countries and boost Icelandic households’ and businesses’ purchasing power abroad to an unsustainable degree.
We expect a marginal appreciation in the first half of the forecast horizon. For instance, by H2/2026, the ISK could be approximately 2% stronger against the euro than it was at the beginning of this year, which translates to an EURISK exchange rate of 143.
The likelihood of a depreciation increases over time, however, if prices and costs rise faster in Iceland than in neighbouring countries. We therefore expect a slight weakening in 2027. If the ISK is stronger in the latter half of the forecast horizon, though, the likelihood of an entrenched current account deficit grows stronger as well, with the associated correction through a depreciation later on.
