2024 starts with a steep drop in inflation

In defiance of all forecasts, the CPI fell unexpectedly in January – the first month-on-month decline in four years. The main driver of the shift is airfares, which fell markedly, although a number of other items rose far less than is customary in January. Headline inflation could fall rather quickly in the months to come.

According to newly published figures from Statistics Iceland (SI), the consumer price index (CPI) fell by 0.16% month-on-month in January, lowering headline inflation from 7.7% to 6.7%. Twelve-month inflation excluding housing has tumbled as well, from 6.7% to 5.2%. The last time the CPI fell between months was four years ago, in January 2020.

The January CPI measurement was below all published forecasts. which provided for increases ranging from 0.3-0.6%, including our own forecast of 0.4%. The main surprise in the January measurement came from the travel and transport component, with motor vehicle prices rising far less – and airfares falling more – than we had expected.

Seasonal sales and airfares the main downward-pushing items

Winter sales were at their deepest since before the pandemic and therefore weighed heavily in this month’s drop in the CPI. Clothing and footwear fell in price by 9.2% MoM (-0.36% CPI effect) and furniture and housewares prices were down 5% (-0.29%).

The travel and transport component fell also, contrary to our expectations. As a whole, it fell by 0.6% (-0.1% CPI effect), owing mainly to an 11.2% drop in airfares (-0.22% CPI effect). This was offset, though, by a 1.1% increase in motor vehicle prices (0.07% CPI effect) and a 0.9% rise in petrol prices (0.03%). This was the component that took us most by surprise in SI’s January measurement. We had assumed a far smaller decline in airfares, particularly in light of how little they rose in December. We also expected motor vehicle prices to rise more steeply following the cancellation of tax concessions on new electric and hydrogen-powered cars. As the chart shows, the travel and transport component is the one that deviates the most from our forecast.

The January increase in the CPI was fuelled mainly by the housing component, as is discussed more fully below. Apart from housing, food prices rose most according to SI’s measurements, or by 0.5% (0.08%). Alcoholic beverages and tobacco rose in price by 3% (0.07%), owing to unit-based increases implemented at the turn of the year. The hotel/restaurant component rose 1.2% (0.06%) and the health component by 1% (0.04%).

Housing component the main source of inflation

The main driver of inflation this January is the housing component, which rose by 1.1% (0.32% CPI effect) overall, with imputed rent rising 0.9% (0.18%) and heat and electricity by 3.7% (0.12%). Imputed rent is a composite measure of housing market prices plus an interest component based on indexed mortgage rates. House prices rose by 0.25% this month, and the interest component increased by 0.7%. House prices have risen only modestly in the past two months, which is a radical change from the period beforehand, when they were among the chief items pushing the CPI upwards.

Year-on-year house price inflation has picked up slightly in recent months and currently measures 4.7%. In the past year, prices in regional Iceland have risen the most, at 8%. Next in line are capital area condominium prices, are up 4.1% in the past year, followed by detached home prices in the capital area, which have increased by 3.2% over the same period.

The outlook for the months ahead

Inflation is falling faster than we had anticipated, which is very good news indeed. We expect it to keep tapering off in coming months, and at a brisk pace. According to our preliminary forecast, the CPI will rise 0.8% in February, 0.5% in March, and 0.7% in April. If these projections materialise, inflation will measure 5.3% in April. The reason for such rapid disinflation is that large monthly rises from H1/2023 are starting to drop out of twelve-month measurements. The main item that must fall into line in the short run is the housing market, which must be on its good behaviour. That said, we do expect house prices to rise MoM in the coming term. We will include our long-term inflation forecast in our quarterly macroeconomic forecast, set for publication tomorrow.


Bergthora Baldursdottir