We project that the consumer price index (CPI) will rise by 0.4% month-on-month in May, lowering headline inflation from 9.9% to 9.5%. The main driver of this month’s CPI increase is the housing component, followed by food prices. These are offset by a drop in airfares and petrol prices. We project that the February measurement will prove to have been the peak and that inflation will subside in coming months. Statistics Iceland (SI) will publish the CPI for the month on 26 May.
Headline inflation set to ease in May
Íslandsbanki Research projects that twelve-month inflation will fall in May. If the forecast materialises, inflation will decline from 9.9% to 9.5%. The hope remains that it peaked this past February and is now on a downward path. Even so, a number of factors must align in order to bring inflation back to target in the next few years.
House price index suggests that imputed rent will rise
Developments in the housing market have taken us quite by surprise. House prices rose by 1.8% last month, after several months of relative calm. According to the house price index, published late yesterday, capital area home prices were up 0.8% between March and April.
The house price index is a reliable indicator of where house prices are headed in May. In recent months, SI’s measurements have been less volatile than the house price index has, but this changed in April, when both of them jumped – house prices by 1.8% and the house price index by 1.5%.
Our own house price measurement accords with the newly published house price index data, and we project that imputed rent will rise by 1.5% MoM, including a 0.8% increase in house prices and a 0.7% increase in the interest component. Prices in the market are still climbing, but much more slowly than in April.
Food prices up, airfares down
Apart from the housing component, food prices are the main driver of inflation this month. According to our forecast, food and beverage prices will rise by 0.7% MoM (0.11% CPI effect), about the same as in March and April – setting aside the recent hikes in dairy product prices, that is. We then expect the price of food and other imported goods to rise more slowly in the months to come. Other upward-pushing items are hotels and restaurants, which will rise by 1.1% due to increased demand (0.05% CPI effect); recreation and culture (0.03% CPI effect); and other goods and services (0.03%).
The travel and transport component is the only one to fall between months. International airfares have plunged 24% in the past two months combined. They typically fall in May, and this time we expect a decline of 7.9% (-0.16% CPI effect). Furthermore, our measurements indicate that petrol prices will fall by 1.6% (-0.06%).
Twelve-month inflation rose marginally to 9.9% in April, in defiance of forecasts. All components contributed to the increase, and we will take the liberty of assuming that developments in the housing market left most observers dumbfounded. We project that inflation will prove to have peaked in February and will subside in coming months. We forecast that the CPI will rise by 0.6% in June, 0.3% in July, and 0.3% in August, leaving headline inflation at 7.8% in August, if our projections materialise.
Considerable uncertainty remains, however. Forecasting inflation has been diabolically tricky in the recent term, with uncertainties lurking around every corner. At this point, inflation has been 9-10% for nearly a year, and we can see signs of a shift ahead. For instance, inflation has been subsiding in Iceland’s main trading partner countries, and rather rapidly – it is very positive for the domestic inflation outlook that, of the 9.9% headline figure in April, nearly 3% was due to imported inflation.
Furthermore, the housing market looks set to be calmer in the near future. Demand is still in evidence, but high interest rates and tight borrowing conditions should dampen it. That said, house prices could keep fluctuating – dragging inflation along with it. But even so, we expect house prices to seek equilibrium soon.
Although it is quite possible inflation will fall quickly in coming months, there is a long slog ahead, and a number of factors must be in sync in order to bring it back to the CBI’s 2.5% target. We do not expect this to happen during the forecast horizon. According to our long-term forecast, inflation will average 5.2% in 2024 and 3.7% in 2025.
This report is compiled by Islandsbanki Research of Islandsbanki hf.
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