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Disinflation suffers a short setback

We forecast that headline inflation will rise from 9.3% to 9.6% in December. This will only be a temporary hiccup in the disinflation process, though, and will probably reverse right after the turn of the year. Thus the short-term outlook is somewhat bleaker than before, but the long-term outlook is virtually unchanged.

We project that the consumer price index (CPI) will rise by 0.7% month-on-month in December, pushing twelve-month inflation upwards from 9.3% to 9.6%. The key driver of the increase is an explosion in airfares, followed by the continued rise in house prices, albeit at a slower pace than in recent months.

If our forecast materialises, headline inflation is merely following the erratic path seen recently in house prices. Inflation peaked at 9.9% in July, not least because of another surge in airfares like the one we expect this month. Since then, it has trended more or less downwards, with the exception of the slight uptick in October. Statistics Iceland (SI) will publish the CPI for the month on 22 December.

Airfares the main driver of inflation in December

The main reason for this month’s upsurge in inflation is a massive increase in international airfares, which our measurement suggests will rise by 23% MoM. The air transport component of the CPI, which captures both domestic and overseas airfares, will therefore rise by 21% (0.40% CPI effect), according to our forecast. This is a reflection of the usual seasonal pattern, in which airfares rise in December and settle down again in January and February. This puts a positive slant on otherwise bad news, then, for even though we expect inflation to rise in December because of higher airfares, the increase will largely evaporate in the months to follow.

Food and beverages have also kept rising in price. We project that they will increase by 0.4% (0.07%), owing to the depreciation of the ISK. Furthermore, we measured a 0.6% increase in the price of furniture and housewares (0.04%).

According to our forecast, only one item will decline in price this month: petrol, which we expect to fall by 1.1% (-0.04%).

House prices and interest component pulling in the same direction

The housing component takes a backseat to airfares in this forecast, but nevertheless, we expect the component as a whole to rise by 0.5% (0.16% CPI effect), owing mainly to a MoM increase of 0.7% (0.14%) in imputed rent. Even so, this is a smaller rise than we have seen in the past two months.

Imputed rent is a composite metric based on the market price of housing – itself largely a reflection of house prices – and an interest component, which reflects changes in the twelve-month average indexed mortgage lending rate. The interaction between these two subcomponents has changed in recent months, in that now both of them are pushing the CPI upwards. We expect the interest component to keep increasing in the coming term, but we also expect the rise in house prices to lose steam. Twelve-month house price inflation has subsided in the past three months, to 21.2% in November.

Inflation to ease in the new year

Even though we forecast that inflation will rise in December, we are quite sanguine about the months to follow. As is noted above, the December spike is due to a seasonal surge in airfares, which in all likelihood will make a u-turn in the next few months. As a result, it is highly probable that headline inflation will ease at the beginning of 2023, when months with hefty price hikes drop out of twelve-month measurements.

In our short-term forecast, we project that the CPI will decline by 0.3% in January, with seasonal sales pushing downwards and increases in public levies and services prices pulling in the opposite direction. We then expect the CPI to rise by 0.5% in February and 0.3% in March. If this forecast is borne out, headline inflation will measure 7.4% in March.

According to our long-term forecast, inflation will average 6.4% in 2023 and 3.9% in 2024. As always, the situation is highly uncertain, and even though it has to be considered likely that inflation will fall swiftly in the new year, a number of factors must line up if that is to happen. First of all, the housing market needs to cool down and the ISK to stabilise, mainly to keep imported inflation in check. Another major uncertainty is the still-outstanding wage agreements, which we hope will be settled in the days or weeks to come.


Bergthora Baldursdottir




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