October was certainly an eventful month for the economy and uncertainty about the economic outlook has hardly diminished in recent weeks. A malfunction at the Norðurál aluminium plant in Grundartangi could take a considerable toll on Iceland’s export revenues in the coming months, with effects possibly amounting to around 1% of GDP. The Supreme Court ruling in the interest rate case also marked the month and it remains unclear how much the ruling will affect the supply of housing loans and, consequently, the outlook for the housing market. In addition, the government introduced its first package of housing measures, aimed, among other things, at increasing the supply of homes and reducing incentives to accumulate apartments for rental purposes.
Amidst all these developments, we released our economic forecast to 2028 on 22 October. The forecast, titled Cooling Economy but Strong Consumption, projects modest economic growth in the coming years. We expect that growth will be driven primarily by increased private consumption, as well as gradually rising exports and investment in certain years. It should be noted that the forecast was published before Norðurál announced the malfunction and, as a result, growth for next year is likely overestimated, while growth for 2027 may be underestimated.
Inflation rose more than expected in October, measuring 4.3%. It is concerning that underlying price pressures appear to have increased, particularly in food and various services. The upcoming increases in airfares related to the fall of Play have yet to appear in the price index and airfares rose much less than we expected in October. We believe inflation will remain at 4.3% throughout this year before rising to 4.5% in January 2026, partly due to changes in government fees on vehicles. We consider it almost unthinkable that the Central Bank will lower the policy rate at the next Monetary Policy Committee meeting on 19 November.
The ISK weakened in the final days of the month after strengthening in the first half. Foreign investors began selling government bonds in the last days of October and expectations of a weaker ISK may have increased following reports of the malfunction at Norðurál. Some may also have anticipated a rate cut and thus a narrowing of the interest rate differential. However, last week’s inflation figure must surely have erased any expectations of a rate cut, so it will be interesting to observe how the exchange rate develops in the coming days and weeks.
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