Free school meals and a drop in airfares push the CPI strongly downwards

Government measures to facilitate wage negotiations early this year packed quite a punch this month. The wage agreements provided for fully subsidised school meals starting with the current academic year. We had expected the impact of this to show in the education component, but it actually came to the fore in a drop in cafeteria prices, which fall under the hotel and restaurant services item. The decline itself was in line with our forecast, but because of its inclusion with the hospitality industry, its impact was noticeably stronger. Cafeteria prices fell by 35.9% (-0.26% CPI effect), and as a result, the hotel and restaurant services item fell by 5.33% (-0.29%).

Airfares were the main driver of the decline in the CPI this month, falling by 16.5% /-0.37% CPI effect). The price reduction is an annual occurrence that usually shows in the wake of the summer tourist season. Furthermore, food prices fell for the second month in a row, this time by 0.18% (-0.03%), whereas we had projected a decline of 0.5% (-0.07%).

End-of-sale effects consistent with expectations

End-of-sale effects usually surface as price cuts reverse during the months following summer sales. This time the impact was as we had expected. Clothing and footwear prices rose by 5% (0.18% CPI effect), which is well in line with the 5.2% (0.18%) increase we had forecast. Furniture and housewares prices rose 1.5% (0.08%), whereas we had projected an increase of 1% (0.06%).

Imputed rent rose 0.7% (0.14%), slightly above our forecast of a 0.65% (0.12) increase. Thus far, SI’s new imputed rent calculation method appears to have dampened fluctuations, as imputed rent has lain in a relatively narrow range in recent months, particularly as compared with calculations using the old method.

Underlying inflation falls by all measures

All measures of underlying inflation fell in September. Code 4 inflation and the CPI excluding housing are rapidly converging on the target, with the latter now measuring 2.8%. The Central Bank (CBI) Monetary Policy Committee (MPC) pays close attention to these measures, using them as a barometer for underlying inflationary pressures and for the economy more broadly.

Inflation set to fall below 5% by the year-end

Even if one looks past one-off effects, this month’s CPI measurement still shows that the economy has cooled. Although this measurement will surely come as good news to the MPC, we think a policy rate cut at the Committee’s meeting next week is unlikely. That said, we think the arguments in favour of a rate cut in November have piled up since the MPC’s last meeting this August. Today’s numbers play a major role, and we consider it likely that the MPC will signal the possibility of a rate cut before the year-end, jump-starting the monetary easing process in November. We recently forecast a 0.25 percentage point policy rate reduction in November, but the probability of a larger rate cut at that time has grown stronger with this morning’s news.

Airfares fell more than expected, while the reduction in food prices was slightly smaller, perhaps indicating that the impact of the entry of a new player in the grocery store market is tapering off for now. We have revised our preliminary forecast markedly downwards with today’s publication, owing mainly to a more favourable initial position, as we think the overall outlook for the coming term is unchanged. Inflation looks set to fall below 5% in coming months if our forecast is borne out. Our updated preliminary forecast is as follows:

• October – CPI to rise 0.2% (twelve-month inflation 4.9%)
• November – CPI to rise 0.2% (twelve-month inflation 4.7%)
• December – CPI to rise 0.4% (twelve-month inflation 4.7%)

In order for our forecast to materialise, wage drift must be limited and the ISK exchange rate stable. The ongoing wars in various parts of the world are another uncertainty, and any escalation on that front will affect cross-border trade, prices, and economic developments in Iceland and abroad.