Eco­nom­ic fore­cast to 2028: Slow eco­nom­ic growth in Ice­land

There was a setback in the battle against inflation when it began rising towards the end of last year and in the first months of this year. Hikes in public fees and levies were a weighty component alongside higher oil prices caused by the conflict in the Persian Gulf. How soon the flame of inflation can be banked depends to a large degree on the length of the conflict in the Middle East. That said, external factors are not the sole cause of rising inflation - considerable wage growth has also pressured inflation upward.

The state of the labour market is rather uncertain currently. Our inflation forecast assumes that inflation measurements will exceed 4.7% in August, meaning that the revision provisions in collective bargaining agreements will be triggered. Should the parties not agree on remedial action, the agreements can be terminated. This is concurrent with rising unemployment and lower demand for labour.

Highlights of the economic forecast to 2028

• Economic growth will be 1.7% this year, 1.6% next year, and 1.8% in 2028, assuming the forecast holds true. Growth will be carried not least by increased service exports from data centres.
• Inflation recedes slowly and the policy rate will be raised. We forecast 4.8% average inflation this year with uncertainty about the development of inflation depending to a large degree on the armed conflict in the Middle East. We expect the Monetary Policy Committee of the Central Bank of Iceland to raise the policy rate in its next meetings. There is no outlook for rate-cuts until 2027.
• We expect the inflow and outflow of the FX market to continue to be fairly well balanced. The real exchange rate of the ISK is very high. We rather expect the ISK to depreciate slightly during the forecast period.
• We forecast very slow growth in private consumption, a mere 0.4% this year and then 1-2% per year to the forecast horizon. High interest rates, rising unemployment and growing household pessimism will all affect the situation.
• We forecast a contraction in capital formation this year to the tune of 2.3%, 1.9% in 2027, turning to slight growth in 2028. Lukewarm sales of new residential housing and high interest rates will discourage housing development and business investment is likely to contract following high growth related to data centre development.
• We expect to see robust growth in service exports, mainly from the export of data centre services. Also, the capelin season was good this year. Developments are likely to be minimal in tourism which in fact is a fairly good outcome, considering global unrest and the failure of airline Play. In total, we forecast 2.5% export growth this year and 3.6% in 2027, not least because aluminium export will expand again following the completion of repairs to the Norðurál potline that failed in fall 2025.
• We expect rather slower wage drift than hitherto. Despite activation of the revision provision of collective bargaining agreements due to inflation, we expect the parties to arrive at a solution that will align wage increases with the terms of the collective bargaining agreement. Certainly there is significant uncertainty about this issue and we may be underestimating wage development assumptions. We forecast a general 5.2% increase in wages this year and just under 5% in the two following years. Unemployment has grown slightly recently and we expect to see 4-4.5% unemployment throughout the forecast period alongside a calm tempo in the economy.
• Development in the residential housing market has been very moderate with hight interest rates, altered financing options and high volume housing construction recently all having an effect. We expect to see these developments continue while interest rate levels remain high and for nominal prices to grow by just 2% this year and 2.6% in 2027, leading to a reduction in real prices both years. In the last year of the forecast period, we expect housing prices to grow by 4%.