Icelandic Financial Market Digest 29. júní

Publisher: Íslandsbanki Research • Resp.Editor: Ingólfur Bender

Disinflation: courtesy of competition and the ISK

The appreciation of the ISK in the first half of the year and growing competition in the retail sector have combined to reduce headline inflation in recent months, in spite of a strong increase in house prices and rising domestic wage costs. The outlook is for a continued tug-of-war between these forces, resulting in modest inflation overall. 

According to newly released figures from Statistics Iceland (SI), the consumer price index (CPI) was unchanged month-on-month in June. Twelve-month inflation now measures 1.5%, down from 1.7% in May, and is now at its lowest since August 2016. The CPI excluding housing fell by 0.41%, however, and twelve-month inflation thus measured is negative by 3.1%. This large difference between the CPI with and without housing reflects the fact that house prices have been by far the strongest upward-pushing component of the index, while reduced imported goods prices have tended more and more to pull the CPI downwards.

The June CPI measurement is towards the low end of official forecasts. We had forecast a MoM increase of 0.2%, while other projections ranged from no change to an increase of 0.2%. The difference between our forecast and SI’s measurements lies primarily in a larger decline in the price of food, furniture, and recreation and culture than we had anticipated. On the other hand, clothing prices rose considerably more than we had expected, which took us slightly by surprise given the strength of the ISK and the stiffening competition in the local market

Housing, airfares, and clothing push the CPI upwards

As it has in the recent past, the housing component contributed most to the CPI increase in June (0.30% CPI effect). Of that total, imputed rent, which mainly reflects developments in house prices, rose by 1.2% (CPI effect 0.24%). Even though this is a sizeable increase, it is the smallest since July 2016. We attribute this to the season, of course, but we also see signs that the rise in house prices is losing some momentum. 

International airfares rose by 11.6% (0.13% CPI effect), in line with our expectations and the seasonal peak in the tourism industry. In spite of this increase, international airfares have fallen by nearly 13% year-on-year, owing to the appreciation of the ISK and increased competition in the market. 

What took us more by surprise was the 3.5% MoM rise in clothing prices (0.11% CPI effect). We had actually expected a decline in this item, given the increased competition in the domestic market and the recent appreciation of the ISK. On the other hand, the increase in hotel and restaurant services was more modest than we had anticipated (0.02% CPI effect), perhaps reflecting caution among tourism operators, as the strength of the ISK has raised the foreign currency price of their services. 

Downward pressure from ISK appreciation and increased competition

Offsetting the above items are a number of CPI sub-components that are pushing downwards this month. Chief among them is the 1.2% drop in food and beverage prices (-0.16% CPI effect), not least due to a marked decline in the price of vegetables, fruit, poultry, and beverages. 

Various specialty imports also declined in price. These include furniture and housewares (-0.09% CPI effect), petrol (-0.08%), motor vehicles (-0.08%), television sets and other recreational electronics (-0.04%), and drugs and medical supplies (-0.03%). The appreciation of the ISK in the first five months of the year is doubtless a strong contributor here. Furthermore, the entry of Costco into the Icelandic in May has strongly affected various imported goods prices, although the store itself is not yet included in SI’s measurements. 

The opening of Costco is actually just the most recent step in the past few years’ move towards stiffer competition in the Icelandic retail market. This trend has seen a number of foreign retail chains open stores in Iceland, while Icelanders remain eager to buy clothing abroad when travelling and are buying more and more from international online merchants. This has given a considerable boost to Icelandic households’ purchasing power, which is actually underestimated in SI’s measurements as they do not include trade with foreign online merchants or clothing purchases during overseas travel. 

Continued modest inflation

The outlook is for a slight uptick in inflation over the next few months. We expect inflation to remain somewhat below the Central Bank’s (CBI) 2.5% inflation target, however. A stronger ISK, increased competition in the retail market, and slower house price increases than in recent months will combine to keep inflation in check in the near term. We forecast a 0.1% decline in the CPI in July, a 0.5% rise in August, and a 0.3% rise in September, bringing headline inflation to 1.7% in September. 

We project that, on average, the housing component will be the main driver of the rise in the CPI over the period, contributing about 0.23% per month. Furthermore, seasonal sales will affect the CPI in July, as usual, as will end-of-sale effects in August and September. We also expect a seasonal rise in airfares in July, followed by a decline in August and September. 


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