The monetary stance has been tightened in recent months, both in Iceland and abroad, with declining inflation and unchanged interest rates. It is expected that interest rates have peaked, and developments in asset markets suggest that investors are more optimistic than before. Global economic uncertainty remains, however, not least because of armed conflict. GDP growth has slowed markedly in Iceland. Rising real interest rates and increased debt service burdens put a damper on the domestic economy, and high financing costs put constraints on companies’ operations.

Growth in tourism, Iceland’s leading export sector, has slowed. Indicators suggest that tourist’s average stays are shorter than before and that they spend less while in the country. Higher prices are certainly a contributing factor, as Iceland is now a more expensive destination than before. Furthermore, the volcanic activity on the Reykjanes peninsula has cut into demand, at least in the short run. Even so, there have seldom been as many flight offerings to and from Iceland as there are now. Icelandic airlines’ operating performance has deteriorated, and increased supply of flights is expected to show in more competition, lower airfares, and reduced passenger load factors.

Housing market activity has picked up again. Turnover has increased, whereas the supply of new homes for sale has been virtually flat recently. A growing share of home purchases are financed with CPI-indexed loans, which support market activity despite high interest rates and borrower-based restrictions. The deviation of home prices from long-term trend has narrowed in tandem with a gradual decline in real house prices. The Government buy-up of homes in Grindavík could somewhat affect the market for home purchases and rentals.

The financial position of the large commercial banks is strong. Their capital ratios are high, returns on regular operations are sound, and private sector arrears are at a low. The banks have maintained their strong foreign liquidity position by issuing bonds in foreign credit markets. The banks are well cushioned against external shocks. Impairment could increase in coming months, however, as many borrowers’ debt service burdens have increased concurrent with a slowdown in economic activity. Furthermore, fixed-rate periods on many mortgage loans are set to expire in the next 12-18 months, ultimately pushing debt service burdens higher for the affected households.

It is important to ensure that financial institutions can provide uninterrupted service and to safeguard the operational security of financial market infrastructure to the maximum extent possible. Operational risk is on the rise, owing to technological innovation, attempted cyberattacks and cyberfraud, and other causes. It is vital to continue harmonising responses and communications among official entities, particularly during emergencies, so as to delineate clearly the division of tasks, responsibilities, and authorisations. It is also essential to continue shoring up the resilience of financial market infrastructure by strengthening possible substitute methods for domestic payment intermediation, whether it be with cash or with an independent domestic retail payment solution.