Many central banks abroad began cautiously easing their monetary stance after inflation moved closer to target levels and economic activity started to lose pace. The global economic outlook remains highly uncertain, however. In Iceland, inflation has been persistent. Economic activity has slowed in 2024 to date, as the monetary stance is quite tight. The real interest rate, particularly the short-term rate, has risen again recently. The effects of this on asset markets – especially the housing market – have thus far been limited.

Prospects for tourism, Iceland’s leading export sector, have worsened. Growth in the sector has been muted this year, and there are signs that tourists’ average stays have grown shorter, particularly in regional Iceland. The status of bookings over the next few months is poorer than at this time in 2023. Higher prices are doubtless a factor. Flight availability on flights to and from Iceland will contract year-on-year in coming months.

In the past few months, households and businesses have been responding to rising financing costs, such as by seeking out indexed loans to limit their debt service burden. Arrears on loans from the banks have risen only slightly and remain very limited. Most households with mortgages have a strong equity position, owing to the past several years’ surge in house prices.

Home prices remain high by most measures, as steady GDP growth, low unemployment, rising real disposable income, and immigration have supported the market. Housing market activity grew in the spring, owing to the Government buy-up of Grindavík residents’ homes and the knock-on effect of the purchase programme. Even so, the number of homes for sale on the market is virtually the same as at the beginning of the year. The number of newly built homes for sale has risen marginally over this period. Stronger activity has put pressure on home prices, and the share of properties selling at a premium on the asking price is up year-on-year. A growing share of purchases are financed with indexed loans. This supports market activity despite rising interest rates, generally shorter loan maturities, and restrictive borrower-based measures.

The large commercial banks are well positioned. Their capital ratios are high, returns on regular operations are sound, and private sector arrears are limited. The Central Bank’s annual stress test indicates that they are highly resilient against external shocks. Nevertheless, borrowers’ heavy debt service burdens plus reduced economic activity could cause arrears to increase in coming terms. As yet, arrears are limited mainly to specific firms facing operational difficulties. The strong equity position of many borrowers provides them the scope to refinance.

The large commercial banks are well positioned. Their capital ratios are high, returns on regular operations are sound, and private sector arrears are limited. The Central Bank’s annual stress test indicates that they are highly resilient against external shocks. Nevertheless, borrowers’ heavy debt service burdens plus reduced economic activity could cause arrears to increase in coming terms. As yet, arrears are limited mainly to specific firms facing operational difficulties. The strong equity position of many borrowers provides them the scope to refinance.