The economy will grow by 2.3% in 2025 and 2.8% in 2026. Private consumption will recover as real wages rise. Business investment, which has been held back by high interest rates, will strengthen as confidence increases and financial conditions improve. Housing investment remains strong as pent-up demand is worked off. Exports will pick up, driven by a modest rebound of marine products and foreign tourism. The labour market will remain resilient. Major domestic risks include another unsatisfactory fishing season and more destructive volcanic activity.

In November the central bank cut the policy interest rate to 8.5%. Consumer price inflation remains high, at close to 5% and is projected to approach the 2.5% target only by the end of 2026, warranting continued central bank vigilance. Fiscal policy is contractionary and set to tighten further despite additional disaster-related spending, to help reduce inflationary pressures and expand fiscal space. Strengthening technical skills, easing professional licencing requirements, and accelerating the recognition of foreign diplomas will help relieve labour market pressures.

The economy has slowed. Consumption is held back by high interest rates and subdued wage growth. Business investment was robust in the first half of 2024 thanks to shipbuilding but is now dropping as financial conditions have tightened. Housing investment remains strong on the back of high population growth and the working-off of pent-up demand. A weak fishing season, notably of capelin, and slowing foreign tourism have triggered a sharp slowdown in exports. The unemployment rate according to the Labour Force Survey rose to around 3.5% in the autumn, but the labour market remains tight with persisting labour shortages notably in the health and technical sectors. The participation rate has reached record levels, at almost 83%. The macroeconomic consequences of volcanic activity on the Reykjanes peninsula have been small so far.

Following weaker export volumes and the ongoing rise of import prices, the current account balance and net export contribution have turned negative. The 2024-28 wage agreements imply a wage increase of around 4% per year (not considering wage drift), slightly overshooting expected inflation for 2025 and 2026 combined.

In November 2024 the central bank lowered the key policy rate by 50 basis points to 8.5%, the second cut since the tightening cycle started in May 2021. It is assumed to decline further in 2025 and, more slowly, in 2026 to under 5.0% by the end of the year. Headline consumer price inflation has gradually declined to just over 5% in October but remains way above the target of 2.5%. Core inflation is also declining and remains driven by house prices and service costs, notably travel-related costs. The trade-weighted exchange rate of the króna remained largely stable over the past six months. Fiscal policy as measured by the underlying primary balance is contractionary and will be tightened further by around 1.1% of GDP in 2025 and 0.9% in 2026 despite additional disaster-related spending. This will help reduce inflationary pressures further and build up fiscal space.

The economy is expected to grow by 2.3% in 2025 and 2.8% in 2026. Private consumption will expand, boosted by the pay rises following the 2024 wage agreements. Residential investment will remain strong helped by improving financial conditions, and persisting housing demand will boost new construction. Business investment will expand as confidence increases and financial conditions become less restrictive, notably in 2026. Exports will grow as the fishing sector will recover and the number of foreign tourists will increase modestly. The unemployment rate will edge up in 2025 but remain steady in 2026 at around 4%. Inflation will continue to fall in the wake of still tight macroeconomic policy but is projected to remain above target until late 2026. It could exceed expectations if wages rise faster than agreed in the 2024 wage agreements or if import prices, notably for food and oil, start rising again. An unsatisfactory fishing catch season could weigh on exports. Volcanic activity on the Reykjanes peninsula could resume, damaging more infrastructure and requiring additional public relief spending.

Investing in education and relevant skills while fostering a good gender balance across professions could help reduce labour market shortages, notably in technical areas and health care. Easing professional licencing requirements could support employment in the service sector and the crafts. Accelerating the recognition of foreign diplomas could help make greater use of immigrant skills. Lowering barriers to entry and strengthening competitive forces would contribute to higher productivity, notably in tourism, construction, and agriculture. The fiscal rules should be reinstated by 2026 at the latest, to ensure that the debt-to-GDP ratio remains on a declining path.