Iceland’s economy is one of the fastest-growing in the OECD, driven by foreign tourism and strong domestic demand. The labour market is tight and wage growth robust, while high wage compression helps maintain a highly egalitarian economy. Inflation is persistent and broadening, and inflation expectations have de-anchored. The fiscal stance is tightening but consolidation could be faster to support monetary policy. Despite progress, barriers to entry remain in many sectors.
Economic growth will come down to 4.4% in 2023 and 2.6% in 2024. Private consumption will slow as wages moderate. So will business investment as financial conditions continue to tighten, and public investment will barely grow. In contrast, residential investment will pick up in the near term to work off pent-up demand. Export growth will slow given only modest growth in major trading partners. The unemployment rate will gradually rise towards 4.5% by the end of 2024.
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The pandemic-related collapse of foreign tourism and international travel, which account for almost a fifth of GDP, highlighted the need to diversify the economy. Iceland needs to improve resilience and find new drivers of productivity and employment growth, in particular given the objective of emission reductions. Boosting skills across the population is hence the top priority, along with reforms to strengthen competitive forces.
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