News
Equilibrium reached in two-year stagnation period
Glitnir Research’s macroeconomic forecast.
A two-year period of stagnation has begun in the Icelandic economy, a period when the economy will reach equilibrium after rapid economic growth and overheating in recent years. We forecast negligible economic growth this year and next year as inflation subsides and the current account deficit narrows.
Current external economic conditions are unfavourable. The impact of the liquidity crisis has been extensive and prolonged, leading to decline in global economic growth. Oil and commodity prices are also very high in historical context. In addition, the economy is tackling the completion of extensive large-scale industry developments and a cut in the cod quota. Various factors therefore weigh on economic growth in Iceland at present.
Domestic demand looks set to contract, both this year and next, but the contraction is offset by an improvement in external trade. The external shocks impacting the economy will thus serve to accelerate necessary development in the direction of equilibrium following the imbalance in recent years. We expect the current account deficit to exceed 14% of GDP this year but shrink to less than 10% as early as next year. In the latter half of the forecasting period we expect the current account deficit to narrow steadily and be close to sustainable levels at the start of the new decade (5-6% of GDP).
We believe that the current exchange-rate driven inflation spike will be short-lived with inflation abating rapidly as the year unfolds and in early 2009. We forecast that inflation will be around 8% over this year, but that it will be close to the Central Bank of Iceland’s inflation target as of mid-next year. House prices have been one of the main drivers of inflation in recent years, but in contrast a decrease in nominal house prices will curb inflation in coming quarters if the forecast materialises. Furthermore, the labour market looks set to slacken gradually in the near term. Our forecast assumes 1.6% unemployment this year and 4% at the start of the new decade. Softening labour market demand will in our opinion mitigate the wage drift and we forecast a more moderate pay rise in the forecast period than we have seen in recent years.
The ISK has faced adversity in recent months. Dislocation of the domestic FX swap market, tight access to foreign credit, the low risk appetite of domestic and foreign investors in addition to a external imbalances have contributed to the recent depreciation of the ISK. However, we believe that markets will improve in the autumn and the ISK appreciate as a result. We expect the ISK TW index to be 142 on average this year but 128 next year. We expect the ISK to appreciate slowly in the latter half of the forecast period as the economy's external conditions improve.
We believe that a four-year policy rate hike period has ended. We forecast that the Central Bank of Iceland (CBI) will lower the policy rate in September and bring the rate to 14.75% by the year-end. We expect the policy rate to be lowered rapidly next year as the economy cools down, private consumption contracts and external trade improves, to stand at 8% at the end of next year. The CBI will start a new, moderate policy-rate hike process in the latter half of the forecast period when the wheels of the economy have started turning again.
Economic growth should revive considerably in 2010 and 2011 when domestic demand growth and favourable external trade will join forces. The liquidity crisis can then be expected to have blown over and global economic growth to have accelerated. Other external conditions can also be expected to have improved. We believe that growth will measure 3.8% in 2010 and 4.6% in 2011.
