Average inbreeding coefficients were calculated for the Icelandic dairy cattle population, using pedigree records of 129 115 animals with the most remote ancestor born in 1902 and the youngest animals born in 1991. The average coefficient for animals born 1980 or later and with at least both parents and one grandparent known was 1.82%, but for animals with at least four ancestral generations known it was 2.70%. No significant trend in inbreeding was detected in the period after 1980 when considering animals with at least four ancestral generations known. The AI bulls were inbred by 2.39% on average and a significant increase in inbreeding of +0.08% per year was detected. The effects of inbreeding level on milk, fat and protein yields in each of the first three lactations were estimated by including inbreeding level in the multitrait animal model currently used for breeding value estimation of the breed. A large proportion (58.6%) of the cows with production records were inbred. Negative effects were detected, corresponding to a reduction of 0.22–0.39% of mean production per 1% increase in inbreeding. Inclusion of inbreeding level in the model did not affect the ranking of animals.