Iceland Must Tackle Inflation and Make the Most of Immigration

Iceland’s economy is currently one of the fastest growing in the Organisation for Economic Co-operation and Development (OECD). Foreign tourism and strong domestic demand are the reasons for this growth, but it is expected to slow, according to the latest OECD Economic Survey of Iceland. The OECD recommends that Iceland’s policy continue to focus on bringing down inflation, strengthening productivity growth by improving the business climate, and helping migrants integrate.

“Iceland has rebounded strongly from the pandemic and has proven resilient in the face of the economic impact of Russia’s war of aggression against Ukraine across Europe and globally,” OECD Secretary-General Mathias Cormann said when he presented the survey in Reykjavík alongside Minister of Finance and Economic Affairs Bjarni Benediktsson. “Continued monetary policy and fiscal policy tightening remain necessary to return inflation to target and properly anchor inflation expectations. Establishing a one-stop to simplify access to migrant integration services, including skills recognition and Icelandic language literacy, will help to optimise the beneficial impact of the increased number of migrants on long-term growth.”

Inflation to decline but persist

Inflation has remained persistent in Iceland despite efforts to tackle it, including consistent interest rate hikes by the Central Bank. According to the OECD survey, it is projected to decline but still exceed 3% by late 2024. Economic growth is expected to moderate from 6.4% in 2022 to 4.4% in 2023 and 2.6% in 2024, according to the OECD. There are indications that Iceland is reaching its capacity for tourism, and as the industry levels off, household consumption is expected to slow and real wages to continue to weaken.

Reforms to business climate recommended

The OECD survey found barriers to entry for domestic and foreign companies to be relatively high in Iceland, despite progress in tourism and construction. It suggested structural reforms to improve the business climate, such as easing the overreaching system of licences and permits and investing in skills relevant to the labour market. Such reforms would reinvigorate productivity, which has been trending upward by only about 1% yearly, and would help with the fight against inflation, according to the OECD.

Aging population a risk to debt sustainability

When it comes to public expenditure, the survey emphasises that spending on health and long-term care is expected to rise considerably as the population ages, although from a lower base than in almost any other OECD country. The survey recommended reforms such as lifting the retirement age and reducing tax expenditures to slow the build-up of debt.

Better integration of migrants required

Figures from the OECD survey show that immigration in Iceland is rising faster than in other Nordic countries and that it brings large economic benefits. The median age of immigrants in Iceland is lower than in any other OECD country, at between 30-35 years, and their participation rate is higher than in any other country, at over 85%.

The OECD survey emphasises that Iceland should step up its efforts to better integrate migrants and their children, such as by establishing a one-stop shop for services, which would make language training courses more effective and would ease skills recognition. More support is needed for students with immigrant background, including more teacher training in multicultural education.

“Successful integration also requires meeting the housing needs of the immigrant population, including through increasing the supply of social and affordable housing,” the OECD press release on the survey states.

An overview of the survey including findings and charts is available on the OECD website.

Central Bank Raises Interest Rates by 1%

Central Bank

The Central Bank of Iceland’s key interest rate will be raised to 3.75%, rising ever-closer to pre-pandemic figures. The Monetary Policy Committee (MPC) announced a 1% interest rate hike this morning. The MPC says the economic outlook has deteriorated due to the impact of Russia’s invasion of Ukraine.

In March 2019, the Central Bank’s key interest rate stood at 4.5%. It was lowered repeatedly throughout the pandemic in efforts to bolster the economy and maintain stability on the housing market. Interest rates reached a historic low of 0.75% in November 2020, but the Central Bank has been steadily raising rates once more over the past year.

Moderate growth expected this year

Despite the worse outlook as compared to February’s forecast, the MPC says there are “signs of strong domestic economic activity” in Iceland, including a tightening labour market. GDP growth is forecast at 4.6% for the year 2022, and a growth rate of just under 3% in 2023 and 2024.

Inflation woes continue

Combating inflation continues to be a challenge, according to the MPC, which cites “house prices and other domestic cost items” as strong drivers of inflation, as well as global oil and commodity prices. Underlying inflation currently measures 5%, with inflation in the month of April measuring 7.2%. The Central Bank predicts that inflation will rise above 8% in the third quarter of this year.

The MPC expects interest rate hikes and “tighter borrower-based measures” to slow down house price inflation and domestic demand. The Committee states, however, that it is likely the monetary stance will have to be tightened even further in coming months to ease inflation. “Decisions taken at the corporate level, the labour market, and in public sector finances will be a major determinant of how high interest rates must rise,” the notice concludes.

Iceland’s Central Bank Lowers Interest Rates Once More

Central Bank Ásgeir Jónsson seðlabankastjóri

The Monetary Policy Committee of the Central Bank of Iceland (CBI) has decided to lower the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate will therefore be a historically low 0.75%. The CBI has been steadily lowering interest rates throughout the year. A press release from the bank states that the economic outlook has deteriorated, in part due to increased COVID-19 restrictions put in place this fall.

“The autumn surge in COVID-19 cases and the tightened public health measures have weakened the economic rebound that began in Q3, following a historically large contraction in Q2,” the press release states. “The economic outlook has therefore deteriorated, and according to the forecast in the November Monetary Bulletin, GDP growth is set to contract by 8.5% this year, a full 1 percentage point more than was forecast in August. GDP growth is projected to be weaker in 2021 as well.”

Economic Outlook “Highly Uncertain”

While the króna depreciated during Iceland’s first wave of the pandemic last spring, it has been relatively stable in the recent term and long-term inflation projections are largely unchanged. Inflation is expected to average around 3.7% until early 2021 and then begin to ease.

The press release describes the economic outlook as “highly uncertain,” saying “economic developments will depend to a considerable degree on the path the pandemic takes.”

Vocational Education and Start Up Support Keys to Boosting Economy

Central Bank Governor Ásgeir Jónsson says vocational education and financial support of start-up companies are the key actions needed to boost the Icelandic economy. Ásgeir shared those thoughts at an open meeting with Alþingi’s Economic Affairs and Trade Committee this morning, RÚV reports. The Central Bank’s economic forecast for the next two year has worsened.

“I am admittedly not speaking as the Central Bank Governor now but […] we have placed too much emphasis on book learning. We are seeing a lot of dropouts from secondary school and are seeing too many people who don’t receive education in any particular field and go out onto the labour market without education. I think we need to in some way emphasise vocational training much more.”

Worse economic outlook for 2020 & 2021

The Central Bank announced yesterday that its key interest rate would be lowered by 0.25 percentage points to 2.75%. The interest rate was lowered 1.5% last year (in stages) to 3.0%, a historic low that has now been outstripped.

Though leading indicators suggest that GDP growth was stronger in 2019 than previously assumed, the outlook for 2020 and 2021 has deteriorated, according to the Bank’s new macroeconomic forecast. Published this month, the forecast projects GDP growth will measure 0.8% this year, compared to 1.6% that was predicted in the November forecast. According to the Central Bank, “The poorer outlook is due primarily to headwinds facing the export sector and tighter financing conditions for domestic firms.”

Less Downturn But Slower Recovery for Iceland’s Economy

Goðafoss tourists Iceland

The Central Bank has lowered its interest rates by 0.25%, making the bank’s key interest rate now 3.5%. The decision is in line with the bank’s economic forecast, which projects less of a downturn in the near future than expected, but a slower recovery for the hard-hit tourism industry throughout next year. Arionbanki’s analysts share this outlook.

“According to the [Central] Bank’s new macroeconomic forecast, published in the August Monetary Bulletin, this year’s economic contraction will measure 0.2%, slightly less than was forecast in May,” a press release from the Central Bank reads. The bank cites several reasons for this change, including private consumption growth, and net foreign trade which have offset a contraction in tourism. The long-term economic outlook, on the other hand, is slightly less positive, according to the bank’s projections. “The GDP growth outlook for 2020 has deteriorated, however, as it now appears that it will take longer for tourism to recover after this year’s setbacks,” the press release states.

Tourists spending more and staying longer

Arionbanki analysts say the newest import and export figures from Statistics Iceland paint a better economic picture than many dared to expect following WOW air’s bankruptcy in March. Though tourist numbers have lowered significantly compared to last year, in general, figures from the tourism industry have turned out better than expected, partly due to the fact that foreign tourists are on average spending more per capita during their stay. “In light of the high card turnover growth per tourist compared to 2018, longer stays, and a weaker króna, it was expected that travel, or total tourist consumption, would contract less than the number of tourists,” the report states. “That became the case, and even more so, as tourist consumption grew by 0.1% year-on-year, despite a 19.2% reduction in tourists.”

Icelandair’s grounded jets outlast WOW’s effects

Central Bank Chief Economist Þórarinn G. Pétursson stated at a meeting today that the worsened long-term outlook is influenced by Icelandiar’s three Boeing 737 Max 8 planes which were grounded due to safety concerns. Icelandair announced on August 16 that the planes would remain grounded at least until next year, not until the end of October until previously expected. Þórarinn states that neither WOW air’s bankruptcy nor that of Primera Air had affected the revisions to the outlook.