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Headline inflation eases slightly

Inflation finally lost a little ground in November, after rising virtually unchecked since the turn of the year. The minuscule rise in the CPI is due partly to lower prices on various imported goods and a modest increase in house prices. Presumably, inflation will remain relatively high through the winter, with developments thereafter depending on how the COVID-19 pandemic plays out.

The consumer price index (CPI) rose by 0.04% month-on-month in November, lowering headline inflation to 3.5% from the October figure of 3.6%. Even with this month’s dip, inflation has been high in 2020, rising from 1.7% in January to the present level. The November CPI measurement, unlike its predecessors, is below all official forecasts, as well as being the smallest single-month rise since January 2020. We had projected a 0.2% rise in the CPI this month. Imputed rent, food and beverages, clothing and footwear, and petrol all declined month-on-month. The last three of these items depend largely on import prices.

CPI up 0.04% MoM in November

Twelve-month inflation as measured by the CPI excluding housing is now 4.2%, which shows that the housing component is still pushing inflation downwards. Food and beverage prices fell by 0.22% (-0.03% CPI effect), driven mainly by vegetables (-2%) and fruit (-0.81%), which fell in price after a significant rise earlier this year. Imputed rent declined as well, falling by 0.15% MoM (-0.02%) in November. The clothing and footwear component fell by 0.7% (-0.02%), with clothing prices declining by 0.58% and footwear by at least twice as much. Petrol prices were down nearly 0.6% between months (-0.02%), while global oil prices have risen steeply in the past few days, reaching pre-pandemic levels earlier this week. This recent hike in oil prices has not yet reached Iceland but will presumably do so shortly.

Key CPI components decline between months

The main difference between our forecast and Statistics Iceland’s (SI) November measurements lies in our overestimation of the rise in imputed rent. House prices did increase between October and November, but less than in the previous five months. Lower debt service due to hefty interest rate cuts earlier this year therefore weighed heavier in imputed rent this month than higher house prices did. As is mentioned above, food and beverage prices fell more than we had projected, as did clothing and footwear prices. This is the first time since 2016 that food and beverages have pushed the CPI downwards in November. Airfares rose slightly less than we had anticipated (0.04% CPI effect) but have been highly volatile and unpredictable this year because of the pandemic.

House prices still rising

House prices have risen nationwide in 19 of the past 24 months, including the past six months in a row. The twelve-month increase has lost momentum since August (1.2%), however, when it measured 7.8%. In 2020 to date, the price of detached housing in the capital area has risen the most (8.2%), followed by condominium housing in the capital and nationwide (6.8%) and housing in regional Iceland (5.9%). Mortgage lending rates have fallen markedly this year, boosting real estate market activity and pushing prices upwards, even in the face of the highest unemployment rate in over a decade. As is mentioned above, imputed rent pushed the CPI downwards by 0.02% in November. The imputed rent component is a composite that includes house prices and the effects of mortgage interest. In November, the downward impact of mortgage interest was greater than the upward impact of house prices because, in the last few quarters, mortgage lending terms have been the most favourable ever offered.

Inflation peak on the horizon?

Although headline inflation has dipped slightly between months, we think the peak has yet to come. We project inflation to average 2.9% in 2020, 3.3% in 2021, and 2.5% in 2022. Positive news about COVID vaccine candidates came earlier than expected, and the most recent Gallup Consumer Confidence Index data indicate that Icelanders are slightly more optimistic at the moment. The future remains highly uncertain, though, particularly to include details about the manufacture and distribution of a vaccine. We base our forecast on the assumption that a vaccine will be widely available by mid-2021, but if efforts to tamp down on the pandemic prove more successful than we anticipate, inflation could taper off more quickly. On the other hand, if the pandemic proves more stubborn, the ISK exchange rate could take longer to recover and inflation could turn out more persistent than we have assumed.


Tryggvi Snær Guðmundsson