Statistics Iceland published GDP growth figures for Q1 this morning. To be frank, the numbers are like the opening act no one came to watch, everyone is waiting with bated breath for the main act, the Icelandic economy following WOW air’s bankruptcy. The economic reality that the Q1 numbers describe no longer exists. That being said, the figures clearly show that the growth period is coming to an end, even in Q1 when there were two domestic airlines operating. GDP grew by 1.7% YoY in Q1, the softest growth per quarter since 2014.
Even though 1.7% GDP growth is low in historical context, it still managed to exceed our expectations, as we had anticipated 0.5% GDP growth in Q1. There are two factors that first and foremast explain the difference. First, housing investment took us by surprise, increasing by 58% YoY compared to our forecast of 4% increase. Second, goods exports proved more resilient than we expected. It should be noted that after our forecast was published, Statistics Iceland revised its monthly external trade figures, increasing exports by four aircrafts that were sold from WOW air to Air Canada at the end of last year. However, as the aircrafts were delivered in January, the sale fell under Q1. We therefore knew that exports and investment would not develop as we had previously forecast. The impact on economic growth is however insignificant, as the sale increases exports but decreases business investment instead. If we were to adjust our forecast and take the exported aircrafts into consideration, our exports forecast for Q1 goes from 7.6% contraction to 0.5% contraction. Despite the change, our export forecast would still have some way to go to reach the 2.6% reported export growth, but, as previously mentioned, goods exports proved more robust than we expected.
The Central Bank of Iceland (CBI) published its new macroeconomic forecast last week. The Bank’s GDP forecast for Q1 was not revealed, other than that slower economic growth was expected, as proved to be the case. The GDP figures are unlikely to affect the MPC, as slower growth was already expected. Furthermore, the MPC is forward looking, and the figures do not describe the current economic environment.
Sources: Statice, Arion Research
Unlike previous quarters, private consumption was not the main driver behind economic growth, as external trade did the heavy lifting this time around. The reason for such a positive contribution from external trade to GDP is primarily the aforementioned aircraft sale, as well as a significant drop in imports. On the other hand, investment and inventory changes weigh down growth, particularly changes in inventories, as no capelin was caught this year, leading to a drop in seafood products inventories.
Sources: Statice, Arion Research
In our discussion of GDP growth in the latter half of last year, we wondered why housing investment hadn’t increased more (it increased by 1.2% in 2H 2018 compared to 2H 2017), as building cranes decorate the horizon and new housing seemingly listed weekly. In Q1 2019 the puzzle was finally solved. Housing investment increased by 58.4% YoY, pushing the current level of housing investment to its highest value ever, in real terms! Housing investment is always quite volatile, especially between quarters. Historically, housing investment spikes in Q4, as contractors finalize the process of listing new housing, or update the level of construction, before the end of the year. This time, the change seems to land on Q1, that is, much of the investment has probably taken place in the latter half of last year, but was only registered or recorded in Q1, explaining the strong growth this quarter. Nonetheless, we expect strong housing investment this year, despite the economy cooling down.
Sources: Statice, Arion Research
Business investment contracted somewhat more than we expected. The aforementioned aircraft sales plays a large role in this context, as the sale is subtracted from business investment. If, however, we look closer, it’s clear that something more is at play here. The most noteworthy development in our opinion is in traditional business investment. Business investment excluding ships, aircrafts and heavy industry decreased by 5.4% YoY in Q1, the fifth consecutive quarter. Continued contraction in traditional business investment is, in our opinion, one of the clearest signs of the economic slowdown in Q1.
Sources: Statice, Arion Research
Private consumption has been the driving force behind economic growth in recent years, as Icelandic households have experienced an almost unprecedented increase in purchasing power. With the strengthening of the króna, purchasing power in foreign currency has likewise grown rapidly. Because of that, an ever growing share of private consumption takes place oversea or is imported, a trend that has been reflected in strong import growth. Private consumption growth has slowed significantly in recent quarters, a development we expect to continue. Some claim that the uncertainty in Q1, both surrounding WOW air and clashes in the labor market, affected household’s consumption, leading to increased savings. This is probably true to some extent, but in our opinion, private consumption growth is likely to slow down even further in coming quarters and we wouldn’t be surprised is negative figures might emerge as unemployment continues to climb. Autumn might prove to be especially difficult for Icelandic households, when the high season in tourism comes to an end.
Sources: Statice, Arion Research
Over the past few weeks, analysts have been busy updating their forecasts for the Icelandic economy. We were the first to publish an economic forecast, called “Winter is here”, just a few days after WOW air collapsed. Based on the title, it may not come as a surprise that our forecast is considerably more pessimistic than others who have followed, e.g. new macroeconomic forecasts by Statistics Iceland and the CBI. As we have spoken candidly about, it’s easy to argue that we are too pessimistic for this year. After our forecast was published, more moderate wage agreements than initially expected were signed, payment card turnover figures were revised upwards and Icelandair's route network proved to be much more flexible than we expected, i.e. shifting focus from VIA passengers to travelers visiting Iceland. Nevertheless, we fear that other analysts are too optimistic about the economic outlook.
In the latest issue of Monetary Bulletin, the CBI published two alternative scenarios to their economic forecast, one where tourist arrivals decrease by 15% YoY and another, where the UK crashes out of the EU (hard Brexit). Since then, the probability of both of these alternative scenarios has increased. Therefore, it´s likely that the CBI’s forecast of 0.4% contraction this year is too conservative. Even though our forecast is perhaps slightly too negative, we believe that the outcome will be somewhere between our forecast and the CBI’s alternative forecasts, i.e. that the contraction exceeds 1%.
Sources: Arion Research, analyst’s forecasts