New Economic Forecast for 2005-2010

The Ministry of Finance has released a new forecast for the Icelandic economy for the years 2005 to 2007 in addition to a longer-term projection until 2010. The forecast is published on the Ministry’s website and may be accessed on the webside - The Icelandic Economy - Economic Forecast for 2005-2010. The forecast covers recent economic developments and prospects for the main aspects of the economy.

The summary of the forecast is as follows:

• The economic expansion is at its peak, with the rapid pace of growth continuing this year and next while the power project investments remain extensive. Growth will slow down in 2007 due to contracting construction activity and declining domestic demand.
• Provisional national accounts data indicate GDP growth in 2004 amounted to 6.2 per cent, due to rising private consumption and investment and in spite of sharply rising imports. GDP growth is expected to remain high this year, about 6 per cent, whereas it is expected to slow down next year, to 4.6 per cent. With contracting construction activity and domestic demand in 2007, the rate of GDP growth is projected to slow to 2.5 per cent.
• An unavoidable consequence of the large scale investments is a current account deficit estimated to peak at 13.3 per cent of GDP this year and amount to over 12 per cent of GDP next year. Increased aluminium exports and contracting imports and the resulting turnaround in foreign trade will drive the growth of GDP in 2007. In the years 2008-2010, the current account deficit is project average 2.2 per cent of GDP.
• The imbalances in the economy during the investment period are expected to be temporary. A tight economic policy is restraining domestic demand. The opening up of the economy has increased competition, limiting the scope for domestic agents to increase prices and wages. Along with flexible arrangements in the economy, which have increased productivity growth, the growth potential of the economy has increased.
• Unemployment has declined and is forecast to be below 2 per cent of the labour force in 2006. The emerging positive output gap is expected to narrow quickly after the power project construction activity has peaked. Unemployment is then forecast to increase.
• The consumer price index has increased mainly because of rising real estate prices. Year-on-year inflation is estimated at 3.9 per cent in 2005. The exchange rate and real estate prices are assumed to have peaked. The exchange rate is assumed to decline moderately in the course of 2006. Inflation is expected to average 3.8 per cent for that year and 4 per cent in 2007. The wage rate is not expected to change much in the upcoming revision of the wage agreements.
• The main elements of uncertainty in the forecast have to do with further power project investments and development of the exchange rate. In this connection, it should be pointed out that in spite of the high debt of households and business, the position of the Treasury is strong and the wealth of the country has increased. The foundations of the economy are sound and its flexibility is considerable.

For further information, please call Thorsteinn Thorgeirsson, Director-General, Ministry of Finance, Economic Department, tel. (354) 545 9200.

3. October, 2005