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26 July 2021

Headline inflation levels off

Rising house prices, fuel prices, and airfares outweighed summer sales in July. The CPI rose month-on-month, but headline inflation remained flat at 4.3%. We expect inflation to start falling further later this year and align with the Central Bank’s (CBI) 2.5% target in Q3/2022.

According to figures released recently by Statistics Iceland (SI), the consumer price index (CPI) rose 0.16% MoM in July, leaving twelve-month inflation unchanged at 4.3%. Twelve-month inflation excluding housing measured 3.4% during the month.

The July CPI measurement is above our forecast of a 0.1% MoM rise in the index. The main difference between our forecast and SI’s measurements lies in the housing component, which rose more than we had anticipated. Furthermore, food prices rose markedly between months, whereas we had expected only a marginal increase.

House prices still climbing

House prices strongly affected the July CPI measurement, as they have in recent months. Imputed rent, which is mainly a reflection of house prices, rose by 0.86% MoM (0.14% CPI effect). The market price of residential property rose by 0.93% between SI measurements, which are based on a three-month average.

In the past twelve months, house prices nationwide have risen 13.2% by this measure. The largest increase was in single-family home prices in greater Reykjavík, which rose by over 17%. Condominium prices in the capital area have risen more than 14% over the same period, and prices in regional Iceland are up by over 8%. Based on these measurements, the rise in single-family home prices in greater Reykjavík has begun to lose pace, while condominium prices have gained steam and are rising at their fastest since the end of 2017.

Travel and transport pushes the CPI upwards; summer sales pull downwards

The travel and transport component was the strongest upward-pushing CPI item in July. It rose by 2% (0.27% CPI effect), as air transport prices increased 10.7% (0.16%) and fuel prices 3.9% (0.12%). Apparently, the air travel market is coming back to life, as international airfares rose by over 11% MoM and are up more than 21% since March.

Offsetting the aforementioned upward-pushing items were a few that lowered the CPI during the month. The summer sales held in July were shallower than we had expected, however. Clothing and footwear prices fell by 5.3% (-0.20%), which is quite modest in comparison with the usual decline of 10% or more during July sales. Food and beverage prices fell 0.6% (-0.09%), and the health component fell by 0.87% (-0.03%) because of a drop in pharmaceuticals prices.

Composition of inflation

It is interesting to examine the composition of inflation at the moment. Of the 4.3% headline inflation figure for July, house prices explain 1.5%, imported goods another 1.2%, services 1.1%, and domestic goods 0.4%. To simplify the picture somewhat, it can be said that imported inflation, housing, and domestic goods and services each account for about a third of headline inflation at present.

The outlook for the months ahead

We expect inflation to remain broadly unchanged until the autumn and then taper off until mid-2022. According to our preliminary forecast, the CPI will rise 0.5% in both August and September, followed by a 0.2% increase in October. If these projections materialise, inflation will measure 4.1% in October. Thereafter, we expect it to fall at a quicker pace, reaching the CBI’s 2.5% target in Q3/2022. For the two years to follow, the outlook is for target-level inflation.

This forecast is based on the assumption that the ISK will appreciate in coming quarters, That said, excessive house price and wage inflation could cause headline inflation to be higher and more persistent.

We are also fairly concerned about imported inflation and the pandemic-induced surge in shipping costs. These factors could cause imported goods prices to rise more than we have assumed here.