The economic environment

The Icelandic economy grew in 2022 despite challenging economic conditions. Iceland dropped all Covid restriction at the beginning of the year, but the jubilation was fleeting as Russia invaded Ukraine in February, triggering a chain of events to which no end is in sight. Although the year was marked by war, it will also be remembered as a year of inflation and interest rate hikes globally. Yet despite this, the economic recovery in Iceland has been swift and stronger than expected at the beginning of the year.

Strong GDP growth in
stormy international waters

The year 2022 got off to a slow start. At the beginning of the year a wave of omicron infections swept across the country, the government responded by resorting to extremely tough and restrictive public health measures and it appeared that the economic recovery would be unpredictable. However, the public health measures were short-lived as less than a month later all restrictions were lifted, both domestically and at the borders. The much talked about herd immunity had been reached, an event which was completely overshadowed by Russia’s invasion of Ukraine. The international community responded with wide-reaching economic sanctions against Russia, commodity prices rose sharply and inflation, which was starting to rear its ugly head after a historically lax monetary stance, began to gather momentum. The Icelandic economy was not immune to this trend, but given that Iceland is an exporter of commodities, primarily through aluminium and seafood, the country found itself in the unique position of seeing its terms of trade improve. In addition, the tourism sector found its feet again and interest in visiting Iceland soared after a two-year period of travel restrictions, with tourist flocking to Iceland anew.

Despite the stormy start, it was a case of full steam ahead for the Icelandic economy in 2022. GDP growth was driven by robust private consumption growth and a resilient tourism sector, while investment other than housing investment also contributed. Despite thriving exports and a 150% increase in tourist arrivals YoY, the year resulted in a current account deficit as household consumption reached new heights. The wanderlust of Icelandic consumers was very much in evidence and left its mark on the year – both in the economic figures and the social discourse. The energy crisis raging in Europe, with its associated inflation effects and diminished purchasing power, has a relatively minor impact on Icelandic households due to the abundance of clean and renewable energy in Iceland. Household consumption therefore snowballed, smashing record after record. GDP growth in 2022 is estimated to have been around 6-7%, far stronger than forecast at the beginning of the year.

GDP growth
Source: Statistics Iceland, Arion bank *First nine months of year
Contributions to growth by expenditure items
Volume change from previous year
Sources: Statistics Iceland, Arion Bank.

Even though the Icelandic economy went through the year largely unscathed, there remains a huge amount of economic uncertainty. No man is an island in economics, and although Iceland is indeed an island, economic developments in this country are to a great extent determined by the fates of our main trading partners, many of which will be facing economic hardship in the new year. 

Shortly after all Covid-related public health measures were lifted, the tourism industry roared back to life. Iceland was virtually sold out over the summer and the quick turnaround proved to be a challenge for the sector, not least in finding people to fill all available positions. In the end, a total of 1.7 million tourists visited Iceland in 2022, a 150% YoY increase and 86% of the number for 2019. In fact, once the impact of the pandemic began to recede the number of tourists rose to 2019 levels. No less important was the fact that the average length of the stay and spending per tourist also increased. In other words, higher yielding tourists were visiting the country. The outlook for the current year is good, bookings are strong and interest in Iceland as a holiday destination does not appear to have dwindled.

However, it wasn’t just the tourism industry which saw its value increase last year, as exports of marine products and aluminium reached record levels. Both sectors experienced huge price increases, and in addition a large capelin quota generated one of the most valuable capelin fishing seasons in recent memory. Rising seafood prices more than compensated for the reduction in the cod quota.

Tourist arrivals via Keflavik Intl. Airport
Source: Icelandic Tourist Board
Share in total exports of goods
Source: Statistics Icelands, Arion Bank, *First nine months of the year.

Despite the fact that exports flourished, they were nevertheless outdone by imports. The desire to travel to sunnier climes knew no bounds and peaked in October when almost one fifth of the population travelled overseas. Although consumption abroad was the mainstay of private consumption growth, domestic spending kept up momentum, not least when it came to buying new cars. On top of this came increased investment growth and price increases, particularly fuel and investment goods. The outcome was a current account deficit of ISK 21 billion during the first nine months of the year, primarily due to one of the biggest trade deficits since records began, while the primary income deficit, caused by improving operating conditions for the aluminium smelters, also played a role.

Current account balance
% af GDP
Source: Central Bank of Iceland, Statistics Iceland, Arion Bank *First nine months of the year


The mounting current account deficit proved to be a major deterrence for the Icelandic króna, which faced an uphill battle throughout the second half of the year. However, it wasn’t just the deficit's fault as DMB’s liquid assets in foreign currency increased sharply from mid-year, the pension funds stepped up their foreign currency transactions and numerous forward contracts involving the króna against foreign currency, which had grown in volume up to mid-year, were closed. As a result, there were few things coming to the aid of the króna, if one discounts the flow of capital from listed new investments and the Central Bank’s FX interventions. The Central Bank trimmed its sails according to the prevailing climate, and got involved on both the buying and selling sides of the market. The Central Bank bought foreign currency for ISK 34 billion – all in the first half of the year – and sold foreign currency for ISK 21 billion.

The global foreign exchange markets were turbulent last year, and most currencies depreciated against the US dollar. All in all, the Icelandic króna ended the year 10% down on the US dollar, 3% down on the euro but gained almost 2% on sterling. As a result, the Icelandic króna was less volatile in 2022 than often in the past and clearly benefitted from the Central Bank’s ample currency reserves, which totalled almost ISK 900 billion at year-end, and the positive international investment position (24% of GDP at the end of the third quarter). The Icelandic economy is a net lender to abroad, not a borrower as used to be the case, and the Central Bank’s foreign currency reserves are well beyond all guidelines, a fact which boosts the resilience of the economy and reduces the risk of balance of payments difficulties.

Net international investment position
Adj. for financial institutions in winding-up proceedings, % of GDP
Source: Central Bank of Iceland, Statistics Iceland, Arion Bank
The exchange rate of the ISK
Source: Central Bank of Iceland


The depreciation of the króna, high inflation among Iceland’s trading partners and climbing commodity prices fuelled substantial imported inflation. Nevertheless, imported goods had nothing on housing prices when it came to contributing to inflation, as house prices rose 21% between years. The annual rate peaked at 25% in July, coinciding with the 9.9% top of the inflation curve. Although the housing market cooled down markedly in the second half of the year, taming inflation proved to be more difficult than originally anticipated, not least due to domestic inflationary pressures and salary increases alongside imported inflation. At the end of the year, inflation measured 9.6%, making it clear that inflation will be more persistent and difficult to deal with than originally thought. Inflation averaged 8.3% in 2022, or 6.1% excluding housing.

The combination of a widening output gap, a tight labour market, vigorous domestic demand and high inflation meant that the Central Bank had no choice other than to raise interest rates, as its object is to maintain price stability with the inflation target set at 2.5%. Tough measures were also necessary to anchor inflation expectations, as they appear to have become less firmly anchored in tandem with rising inflation. The Central Bank raised rates by a total of 4 percentage points, from 2% to 6% in 2022. Despite this series of sharp rate hikes, real interest rates in terms of inflation and various measures of inflation expectations, remained negative at the end of the year.

Interest rates were not the only tool the Central Bank used in its attempt to bring the housing market under control. The bank’s financial stability committee felt compelled to lower the maximum loan-to-value ratio on mortgage loans for first-time buyers and to establish a reference for interests and maximum loan term for the calculation of debt in the Rules on Maximum Debt Service-to-Income for Mortgage Loans to Customers. Despite the tighter monetary stance, housing price increases proved to be more tenacious than most people anticipated.

However, the latest figures indicate that the market is rapidly cooling down, with more properties for sale, prices decreasing between months, and average time-to-sale on the rise.

House prices relative to fundamentals
Indices January 2011=100
Source: HMS, Central Bank of Iceland, Statistics Iceland, Arion Bank
Advertised capital area property and housing price
No. and YoY %-change
Source: HMS, Central Bank of Iceland, Statistics Iceland, Arion Bank
CBI's key interest rates and CBI by expenditure groups
Source: Central Bank of Iceland, Statistics Iceland, Arion Bank


Inflation and interest rate hikes had no visible effect on household consumption which broke record after record. Trips overseas by Icelanders were the driving force behind private consumption growth, but the purchases of new cars, particularly electric cars, also left an impression. Despite private consumption reaching new heights, it is some consolation to know that it was not borrowed. Households amassed large savings during the pandemic and have started to tap into these savings to some extent. Nevertheless, the saving ratio is still above its pre-pandemic average according to the Central Bank’s latest estimate, as disposable income grew more strongly than expected. It should also be noted that inflation in Iceland, and consequently the measured decline in purchasing power differs from other European countries, where the energy crisis directly impacts household spending. In Iceland, where households rely on geothermal and hydropower, the situation is very different, as inflation does not reflect the same increase in cost of living as in Europe, which therefore softens the impact on private consumption.

The conditions on the labour market also supported private consumption. The rapid recovery on the labour market has far exceeded expectations, with the economy regaining all the jobs lost in the pandemic and then some much sooner than expected. Registered unemployment measured 3.4% in December, compared with 5.2% at the beginning of the year, and the number of firms reporting staffing shortages reached its highest level since 2007.

The economic environment and a tight labour market impacted the collective wage negotiations which kicked off at the end of the year. As expected, the negotiations were heated with recriminations coming from both sides of the negotiation table. At the end of the year collective wage agreements covering 80,000 workers were reached. The agreements are short term and provide a rather generous pay increase. Arion Bank’s Chief Economist estimates that nominal wages will increase by 7-8% over the current year. In this context, it should be noted that agreements have yet to be reached for everybody on the private labour market and a large number of agreements in the public market are up for renegotiation in the first half 2023. The estimate is therefore subject to great uncertainty.

Private consumption and real wages
YoY %-change
Source: Statistics Iceland, Arion Bank *First nine months of the year
Registered unemployment
Source: Directorative of Labour


Public finances benefited from the resilience of the economy and growing domestic economic activity, and the treasury’s credit rating bears witness to this. The sovereign rating remained unchanged throughout the pandemic, with the main change last year being Fitch revising its outlook from negative to stable. Fitch and S&P both rate Iceland’s long-term sovereign debt at A, while Moody’s assigns an A2 rating. All ratings agencies rate the outlook as stable.

The 2022 budget was approved with a deficit of ISK 186 billion. As the year progressed and domestic demand soared, it was clear that government finances would benefit on the revenue side. Estimates indicate that the fiscal deficit will be ISK 45 billion smaller in 2022 than forecast at the beginning of the year. The fiscal balance seems set to improve between years as revenues increase in tandem with growing economic activity, while special Covid-19 support schemes have run their course. The fiscal balance according to the 2023 budget has therefore improved by more than ISK 20 billion between years. The fiscal deficit, particularly during the pandemic has unavoidably led to rapidly rising debt. The debt ratio according to the debt rule is expected to fall in the current year, thanks to GDP growth and rising price levels. This is based on the assumption that the government will forge ahead with its plans to divest assets, not least its share in Íslandsbanki.

Central government total balance
ISK bn. and % of GDP
Sources: Statistics Iceland, Ministry of Finance and Economic Affairs. * Excluding irregular and one-off income and expense items.