Iceland’s economy is projected to recover in 2025, with an expected 2.7% Real GDP growth, following a 0.7% decline in 2024. The forecast anticipates continued easing of monetary policy, a rebound in exports, and strong private consumption driven by 2024 wage agreements, as well as rising business investment, all of which is expected to occur as financial conditions become less restrictive. Iceland’s GDP per capita is among the highest, projected at $90,283.81 in 2025.

The population, totaling 389,444 in 2025, is highly concentrated, with 64% residing in the Capital Region around Reykjavik, which covers only about 1% of the country’s land area. This high urbanization is partly sustained by a significant immigrant population, which constituted 17.4% of the national population in 2024.

Key Factors and Challenges

Tight Labor Market & Skills Mismatches: The labor market remains tight, with robust wage growth, despite an uptick in the unemployment rate to 4.0% projected for 2025. Skills mismatches are particularly high among immigrants, and qualified labor is needed in the technical and healthcare sectors.

Inflation & Housing Costs: While inflation is falling, it remains above the 2.5% target, largely driven by housing costs. The housing market is stabilizing but remains tight, with housing construction supported by population growth and easing interest rates. Average detached house prices in the Capital Region reached ISK 145,296,331 ($1,034,506) in January 2025. Rental costs are also rising, with average rent in the Capital Region reaching ISK 3,937 ($28.02) per square meter in February 2025.

Electricity Supply Constraints: Despite abundant domestic electricity, rising demand, particularly for the green transition, is straining the power system, leading to shortages and rising prices.

Need for Reforms: The OECD highlights the need for fiscal framework reform to ensure sustainability and address procyclical spending. Structural reforms are also required to improve education quality (especially for immigrant students), expand electricity generation, and streamline business regulation to boost productivity and growth.