Monetary Bulletin 2026/1

Trading partner GDP grew by 1.9% year-on-year in Q3/2025, slightly above the forecast in the November Monetary Bulletin. Developments still diverge widely from one country to another, however. Ongoing uncertainty about world trade will probably continue to impede growth in economic activity, and the GDP growth outlook is broadly unchanged. Global inflation has eased recently and is still expected to fall further this year, even though services inflation remains high in many economies.

In Iceland, GDP grew 1.5% year-on-year in the first three quarters of 2025, more than was forecast in November. The deviation is due mainly to Statistics Iceland’s revision of previously published figures. On the other hand, Q4 GDP growth is now estimated to have been weaker than previously projected, owing primarily to less favourable developments in investment and a smaller contribution from net trade. Private consumption grew more than previously assumed, however. GDP growth in 2025 as a whole is estimated at 1.3%, or 0.4 percentage points above the November forecast. The outlook for 2026 has also improved, and GDP is expected to grow by 2% year-on-year. In 2027, however, growth looks set to be weaker than was assumed in November, or 2.2%, while the GDP growth forecast for 2028 is relatively unchanged.

Job numbers have stopped rising, and unemployment continues to inch upwards. There are signs that the employment outlook has worsened even more in the recent past. Unemployment is projected to keep climbing, to an average of 4.8% this year, and then start to fall again in 2027. As in November, it is estimated that a slack in the economy opened up in 2025 and will remain throughout the forecast horizon.

Inflation averaged 4.2% in Q4/2025, slightly below the forecast in November. It has since risen considerably, reaching 5.2% in January. The increase is due primarily to the effects of hikes in various public levies and services prices, as well as rising food prices. Underlying inflation measured 4.5% in January and has risen less than headline inflation. Inflation expectations have remained above target. Inflation is expected to decline again in coming months, to 5% in Q1/2026, which is significantly higher than was assumed in November. Because of a poorer initial position, it will also be higher in coming quarters than was forecast in November. Inflation is not expected to fall below 3% until early 2027 and is estimated to be close to the target by mid-year.

The global economic outlook remains highly uncertain, particularly because of prolonged uncertainty about world trade and heightened geopolitical tensions. Furthermore, it is uncertain how quickly inflation in Iceland will subside to target. Weakly anchored inflation expectations and recent cost increases appear to have exacerbated inflation persistence. On the other hand, employment conditions could deteriorate more than is assumed in the baseline forecast, which would slow economic activity and could cause inflation to fall more rapidly.