If our forecast materialises, inflation will increase in March, to its highest since August 2024. We expect it to ease again in April, however. The war in the Middle East has changed the outlook, and there is considerable uncertainty about developments further ahead. The Central Bank (CBI) is under pressure to bring inflation down quickly, owing in part to the assumptions clause in the last wage agreements.
We project that the consumer price index (CPI) will rise by 0.65% month-on-month in March, jacking headline inflation up from 5.2% to 5.5%, the highest Iceland has seen since August 2024.
The rise is due mainly to two factors: hikes in airfares due to the timing of Easter and the spike in fuel prices. Even so, our preliminary forecast indicates that inflation will taper off in the months ahead. Statistics Iceland (SI) will publish the CPI on 26 March.
Transport will have the most impact on the CPI during the month. The category as a whole is set to rise by 2% (0.31% CPI effect), according to our forecast. Airfares generally make their Easter climb in April, but our measurements suggest that this year’s increase will occur in March, as Easter Sunday falls quite early in April. SI’s price measurement week for the month of April will take place after the holidays, by which time the Easter effect will probably have subsided for the most part. It is also possible that most of the Easter spike will occur between SI’s measurements, and if so, airfares could rise less than we have projected here. Our forecast assumes that fares will rise by 9.8% (0.24% CPI effect). Furthermore, fuel prices have soared recently, driven by the war in the Middle East. According to our measurement, they will rise by 5.1% (0.13% CPI effect) in the March CPI.
Winter sales are still tapering off in March. Sales on furnishings and household equipment reversed in full in February, but we expect additional end-of-sale effects to show in clothing and footwear prices in March, and we project that the category will rise by 2.4% month-on-month (0.09% CPI effect).
We expect food and beverages to rise in price by 0.6% (0.09%), owing largely to dairy products, as the agricultural pricing committee raised the minimum price paid to farmers by 0.89%, according to a recent announcement from the Government Offices of Iceland. Rather unexpectedly, food prices have jumped 1.9% in the last two months combined, and it is uncertain whether price hikes will continue in the near future.
Our inflation forecast has changed quite a bit since the war in the Middle East began on 28 February. The initial effects have already made landfall in Iceland in the form of higher fuel prices, with Brent crude spiking more than 30% in just under two weeks. The situation has been highly volatile, however, and it is not impossible that some of that increase will reverse in the near term.
According to our measurement, the price of fuel is up by just over 5% MoM in March. It is clear from price movements abroad that domestic fuel prices will rise higher if the current trend holds. In the forecast, we assume that oil prices will keep climbing in the months ahead, and it is very uncertain whether – and if so, when – they will decline again. There is also major uncertainty about how the war will evolve and how it will affect oil supplies and shipping lanes. If the conflict escalates and there are shortages of oil and other energy sources, the impact will be broader, and the effects will pass through to airfares and shipping costs, thereby exacerbating inflationary pressures even further. Thus far, we project only that fuel prices and, to a lesser extent, airfares will rise in coming months. This is the main difference between last month’s preliminary forecast and this one.
Twelve-month inflation currently measures 5.2%, and in this forecast we assume that it will measure 5.5% in March. This is due in part to a shift between months, as Easter comes early this year, but it is also due to higher fuel prices. Our preliminary forecast for the next three months is as follows:
If our preliminary forecast materialises, inflation will measure 4.5% in June. We also expect it to keep falling in H2, and our forecast suggests that it could be down to 3.7% by the year-end.
In view of recent developments and their impact on domestic inflation, the premises underpinning wage agreements are somewhat in jeopardy. According to the assumptions clause, if twelve-month inflation exceeds 4.7% in August or if annualised inflation for the period from March through August is over 4.4%, a contract review will be triggered. According to our forecast, inflation will be just below these thresholds, but it would take very little to push it above them.
According to our policy rate forecast, published earlier this week, the policy rate will be raised next week. The CBI has less scope than other central banks to look past an inflation burst like the current one, which stems from external sources, because inflation expectations in Iceland are far more weakly anchored to target than those in neighbouring countries. In addition, there is considerable pressure to bring inflation down before the autumn so as to avoid triggering the wage agreement review clause. With all of this bubbling beneath the surface, the CBI’s Monetary Policy Committee indeed in the hot seat.
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