IMF Wraps Up 2026 Article IV Consultation With Iceland

Washington, DC: The Executive Board of the International Monetary Fund (IMF) completed the Article IV Consultation with Iceland [1] and considered and endorsed the staff appraisal on a lapse-of-time basis without a meeting. [2] The authorities have consented to the publication of the Staff Report prepared for this consultation. [3]

Economic activity recovered in 2025, with GDP expanding by 1.3 percent after a 1.3 percent contraction in 2024. Growth was driven primarily by private consumption-supported by strong wage growth-and investment-reflecting a continued expansion of data centers, though leakages to imports were significant. Meanwhile, exports remained subdued in 2025 partly due to a series of idiosyncratic shocks. The labor market has cooled though wage and inflation pressures persist in spite of a broader tightening of policies.

Growth is projected to strengthen to 1.8 percent in 2026 and 2.1 percent in 2027, led by a rebound in net exports as imports normalize, marine exports recover, and data center exports increase, more than offsetting external headwinds from weaker trading-partner growth. Despite a negative output gap, inflation is projected to remain elevated, averaging around 5.2 percent in 2026 and 3.2 percent in 2027, before declining toward the 2.5 percent target in early 2028. While medium-term growth prospects remain favorable, risks to growth are tilted to the downside and risks to inflation are to the upside.

Executive Board Assessment

In concluding the 2026 Article IV consultation with Iceland, Executive Directors endorsed the staff's appraisal, as follows:

Economic activity moderated in recent years, while inflationary pressures remained elevated. Growth has slowed since mid-2023 amid appropriately tight macroeconomic policies and idiosyncratic shocks, yet inflation, inflation expectations, and wage growth remain elevated. The current account deficit widened in 2025, due to imports for data centers and other idiosyncratic factors. The external position is assessed to be moderately weaker than implied by fundamentals and desirable policies.

The economy is expected to recover gradually, but risks to growth are tilted to the downside and inflation risks to the upside. Staff projects growth at 1.8 percent in 2026 and 2.1 percent in 2027, supported by a rebound in net trade and easing financial conditions. Inflation is projected to remain elevated at 5.2 percent in 2026 and 3.2 percent in 2027, before declining toward target in early-2028. Key risks include an escalation of geopolitical tensions, stronger‑than‑expected wage growth, and disruptions to key export sectors. Medium-term growth prospects remain well-supported by continued diversification towards new export-oriented sectors. Policy priorities are thus to lower inflation sustainably to target, anchor inflation expectations, and increase resilience to shocks by further building fiscal buffers and advancing structural reforms.

The fiscal stance is appropriately contractionary and the medium-term fiscal targets are appropriately ambitious and should be fully implemented. The fiscal stance in 2026 and beyond will help lower inflation and build buffers. The temporary reduction in the VAT rate on fuel should remain time-bound and be phased out as planned. Medium-term targets-which place public debt on a firm downward trajectory-are well-calibrated given the economy's exposure to shocks. Longer-term spending pressures from healthcare and infrastructure underscore the importance of sustained discipline and credible medium-term planning, as well as transparent monitoring of credit risk related to below-the-line on-lending. There is scope to raise revenues and reduce spending if needed to meet the MTFS targets, mitigate long-term spending pressures, or scale up infrastructure investment. Options include raising the preferential VAT rate and/or narrowing its coverage, increasing housing-related taxation, streamlining R&D support, and further rationalizing public spending, including through spending efficiency and public sector wage restraint. Plans to establish a state-owned infrastructure company could help mobilize financing, but should have strong safeguards to contain fiscal risks, including careful monitoring and transparent recording of contingent liabilities and off-balance-sheet exposures.

Strengthening the fiscal framework would boost the credibility of the consolidation effort. The amended fiscal rule should help contain spending over the medium term and reduce procyclicality. The authorities' efforts to strengthen the Fiscal Council are welcome, but a meaningful increase in its capacity and resources will be needed. Regular publication of timely and independently-verifiable quarterly fiscal data consistent with the fiscal-rule perimeter would further strengthen transparency and accountability. Expanding the coverage of the budget and the fiscal rules to encompass the entirety of the central government would also improve transparency.

The monetary policy stance remains appropriately restrictive, but vigilance is warranted alongside clear and forceful communication. Further tightening may be needed in the near term if inflationary pressures persist or intensify and policy should remain restrictive until inflation and inflation expectations are firmly anchored at target. Strengthening communication, including using alternative scenarios, would help enhance transparency and anchor expectations. As uncertainty recedes, a gradual transition toward a more forecast-based inflation targeting framework would improve predictability and reduce volatility.

Reserves are adequate for precautionary purposes. Further strengthening of foreign exchange reserves toward the upper end of the Fund's ARA range would enhance resilience to external shocks, while efforts to deepen the foreign exchange market would support broader market participation and improve hedging opportunities.

Systemic risks in the financial sector are contained and the current macroprudential stance is broadly appropriate. Banks remain well-capitalized, profitable, and liquid, with strong asset quality. However, vulnerabilities in parts of the corporate sector-notably construction and tourism-related activities-require vigilance. Borrower-based measures should remain broadly unchanged for now, especially given the slowing housing market. Efforts to reduce reliance on CPI-indexed mortgages may strengthen monetary transmission over time, but should be carefully timed and sequenced given their role in supporting borrower resilience and financial stability.

Financial sector reforms should build on the significant progress achieved in implementing FSAP recommendations. Remaining priorities include strengthening pension fund governance and safeguarding the independence of financial supervision. Efforts to strengthen operational resilience, including against cyber and payments-related risks, remain essential.

Structural reforms should focus on raising productivity and further diversification. Priorities include reducing regulatory barriers and streamlining licensing and permitting processes; addressing skills shortages through education reform, vocational training, and improved reskilling; reforming wage-setting arrangements to better align wage growth with productivity and the inflation target; closing infrastructure gaps; and improving the efficiency of R&D support while strengthening the broader innovation ecosystem. The authorities' recent Growth Plan to 2035 is well aligned with these priorities, and successful implementation will require strong cross-ministerial coordination, prioritization, monitoring and reporting.

EU accession and euro adoption are ultimately political choices that involve balancing deeper integration and potential credibility gains against reduced macroeconomic policy autonomy. While EU membership and euro adoption could deepen integration and potentially enhance policy credibility, it would result in the loss of independent monetary policy and exchange rate flexibility. Should the process move forward, maintaining low inflation, sound public finances, and an exchange rate aligned with fundamentals, while advancing structural reforms to increase productivity and aligning wages with productivity, will be critical to safeguard stability and competitiveness.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] The Executive Board takes decisions under its lapse-of time procedure when the Board agrees that a proposal can be considered without convening formal discussions.

[3] Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent. The staff report will be shortly published on the www.imf.org/Iceland page.