The Icelandic economy– spring forecast 2008 National economic forecast for Is a hard landing imminent? Thorsteinn Thorgeirsson, Director-General, Economic Department 21 May 2008

Main conclusions Despite growing turbulence in financial markets in 2007, GDP growth amounted to 3.8 per cent for that year. Investment, private consumption as well as exports exceeded expectations. For this year, GDP growth is forecast at 0.5 per cent, mainly based on a sharp increase in aluminium exports and a decline in imports. GDP is forecast to contract 0.7 per cent in 2009, in part because of an expected decline in private consumption and housing investment. Business investment is forecast to continue to decline despite the construction of another aluminium plant. For 2010, GDP is forecast to increase by 0.8 per cent as private consumption revives as well as business investment.

Main conclusions, cont’d The external balance is improving rapidly. After peaking at 26% of GDP in 2006, the current account deficit reached 15.5 per cent in In 2008, it is expected to decline to 13.2 per cent, before reaching 7,7% in 2009 and 6.6 per cent of GDP in Unemployment is forecast to increase to 1.9 per cent of the labour force this year and to 3.8% in 2009, but to decline to 3.5 per cent in Inflation is expected to average 8.3 per cent this year and to decline to 3.9 per cent in 2009 and to 2.5 per cent in 2010.

Main conclusions, cont’d There are numerous plans for further energy-intensive investments including related power project construction. Should these plans be carried out, annual GDP growth would be up to 1.5 per cent higher in the years The increase in activity would be accommodated by slack projected to develop in the economy in coming years. Main elements of uncertainty are i) the exchange rate, ii) conditions in international financial markets, iii) further large scale investment projects and iv) civil servant wage agreements later this year.

GDP, domestic demand & current account, In per cent of GDP

Output gap, labour market gap & inflation 1998–2010

Real estate market in metropolitan area

Growth in private consumption per capita, real estate prices and stock market prices

New auto registrations

Private consumption & real disposable income,

IMF alternative scenarios USAEuro-zone World, other

Further large scale investments

Alternative scenario: further large scale investments

Current account

Unemployment rate & wage index

Exchange rate & currency market turnover

Exchange rate & inflation

Interest rate development

Bank lending to domestic & foreign parties

Public investment

Central government revenue balance

Risk premia in European money market spread between 3 mo. EURIBOR & EONIA swap index

CDS spreads for the Icelandic banks

The Icelandic Economy Is a hard landing imminent? The profile of the projections suggests a downturn similar to that seen in The economy is expected to enter a moderate recession in 2009 but a recovery in A hard landing is therefore not expected. Areas of uncertainty include conditions in international financial markets, the exchange rate and further large- scale investment projects. The strong position of the Treasury and the pension fund system along with flexibility and resilience of the economy make it better able to handle present conditions and restore balance.

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