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Has inflation peaked and started falling?

Twelve-month inflation eased in August, for the first time since spring 2021. It appears as though inflation has peaked and is embarking on a downward trend – very slowly at first, and then more rapidly over the course of 2023. The decline is due mainly to the cooling of the housing market and better balanced imported inflation.

According to figures released recently by Statistics Iceland (SI), the CPI rose 0.3% month-on-month in August. Twelve-month inflation has inched downwards to 9.7%, from 9.9% in July. The CPI excluding housing declined as well, from last month’s 7.5% to 7.1% in August. The August CPI measurement is below forecasts. We had projected a rise of 0.5%, whereas forecasts as a whole lay in the 0.4-0.5% range. The main difference between our forecast and SI’s measurements lies in imputed rent, which rose less than we had expected. It can probably be said with some certainty that the housing market has begun to cool off and that home prices will rise more slowly in the coming term.

Housing market settling down

The housing market was the main driver of the August rise in the CPI. The housing component as a whole increased by 0.8% (0.23% CPI effect), owing mainly to imputed rent, which rose 0.9% (0.17%) – the smallest increase in imputed rent since December 2021. Paid rent rose by 0.8% MoM (0.08% CPI effect), and home maintenance and repair was up 3% (0.03%), driven in part by a surge in the building cost index, which forms the basis for the home maintenance subcomponent of the CPI.

It looks as though the housing market has begun to cool, and at a fairly brisk pace. The first signs appeared with the release of house price index data for July, which showed that the index had risen by only 1.1% MoM. This month’s measurement from SI shows that imputed rent rose only 0.9% MoM in August, which accords well with the July house price index measurement. Imputed rent is calculated as a three-month moving average, and because it rose by an average of 2.7% in the months beforehand, it is safe to assume that the housing market was very calm in August. The next few months will give a clearer view of the market and how fast it will cool, but in our opinion, the data already in evidence provide a good indication of what lies ahead.

In the past twelve months, house prices nationwide have soared nearly 25%, according to SI data, with prices in regional Iceland climbing the fastest, at 26.7%, followed by multi-family homes (24.8%) and single-family homes (22.6%) in the capital area. Most data suggest that twelve-month house price inflation has peaked, and hopefully it will slow significantly in coming months.

End-of-sale effects push the CPI upwards; airfares and petrol prices pull downwards

Summer sales generally take place in July and end in August and September. Clothing and footwear prices rose by 3.5% this month (0.11% CPI effect) and can be expected to climb further in September, as they fell by 6.8% in July. In addition, furniture and housewares prices rose by 1.8% (0.11%).

The price of food and beverages has also pushed the index upwards, rising by 0.6% (0.08%) in August, far more than in July. The price hike appears to be distributed across various items, including meat, bread, and vegetables.

Other key items that rose in price this month are other goods and services (0.06% CPI effect) and recreation and culture (0.04% CPI effect).

Offsetting the upward trend was the travel and transport component, which fell markedly between months. The component as a whole declined 2.3% (-0.38% CPI effect), with airfares falling by 7.7% (-0.21%) and fuel prices by 3.9% (-0.16%). Airfares typically fall in August, and this month’s decline is comparatively modest, particularly in the context of the 37% jump seen in the past two months. The relatively small size of the August decline is probably due to strong post-pandemic demand and higher fuel prices.

Inflation outlook brightens

Inflation stems from numerous sources at present, and it is fair to say that pressures are widespread. Of the 9.7% headline inflation figure for this month, 4% stems from housing, 2.1% from imported goods, 1.3% from domestic goods, and 2.2% from services.

As can readily be seen, however, the housing component is the main driver among them, followed by imported inflation. Developments in the past few months suggest that both of these are calming down quite a bit. If this indeed proves to be the case, it would appear that inflation has peaked and is starting on a downward path – very slowly at first, and then more rapidly over the course of 2023. In our short-term forecast, we project that the CPI will rise by 0.3% in September, 0.3% in October, and 0.2% in November. If these projections materialise, inflation will measure 9.1% in November.

But it goes without saying that there is a long road ahead, and much water yet to flow under the bridge before inflation returns to the Central Bank’s (CBI) 2.5% target. We expect inflation keep losing steam as import prices stabilise, the ISK appreciates, and the housing market rebalances. According to our long-term forecast, inflation will average 8.2% in 2022, 5.9% in 2023, and 3.9% in 2024. The outlook is for a cooler housing market and lower imported inflation in the coming term, but one of the key uncertainties in our long-term forecast centres on the forthcoming wage negotiations, which could drag on for quite a while. Hopefully, though, they will ultimately deliver a favourable outcome for the general public while supporting continued disinflation in the years to come.


Bergthora Baldursdottir