We project that the consumer price index (CPI) will rise by 0.9% month-on-month in December, pushing headline inflation up from 8.0% to 8.3%. We believe, however, that this will be the high point and that inflation will start falling apace in early 2024. The main drivers of the December increase in the CPI are the seasonal jump in airfares and still-rising house prices. Statistics Iceland (SI) will publish the CPI for the month on 21 December.
Headline set to climb in December and then ease in 2024
We project that twelve-month inflation will rise in December but then fall fairly quickly after the turn of the year, to around 7% by March. In order for this rapid disinflation to materialise in the immediate future, the housing market must be calm and the ISK must be more stable than it was for much of the autumn.
Airfares poised for the usual holiday spike
The main contributor to this month’s uptick in inflation is airfares, which we expect to increase by 20.5% (0.35% CPI effect), reflecting the typical holiday surge. The main item pulling in the opposite direction is fuel prices, which are set to fall by 0.9% (-0.03%), owing to the fairly swift drop in the global price of Brent crude.
Various other items will rise in price month-on-month, presumably due in part to the weakening of the ISK in the past few months. According to our forecast, food and beverages will rise in price by 0.4% (0.06% CPI effect) and furniture and housewares by 0.7% (0.04%). Our projections for other CPI components can be seen in the table above.
House prices one of the key culprits
The second-strongest driver of this month’s increase in the CPI is house prices. Even though the market is far healthier than in the recent past, it is still quite lively. After a tranquil summer, prices turned upwards again in the autumn, and over the past three months, the market price of residential property (SI’s measurement of house prices) has climbed more than 3%.
We expect this upward trend to continue in coming months, albeit at a reduced pace. We project that imputed rent will rise by 1.7% MoM (0.33% CPI effect) in December. This is due in no small part to the interest component, which we expect to account for 0.7% of imputed rent, with the other 1.0% stemming from house prices.
House prices have been quite volatile recently, complicating the forecasting process. As the chart shows, we expect house prices to rise more slowly in coming months. We think it likely that the leap in prices this autumn was due in part to more generous terms on participating loans and to the recent surge in population. We expect the housing market to be more tranquil in the coming term, owing mainly to high interest rates and tighter lending rules imposed by the Central Bank, in tandem with growing supply.
Will inflation finally fall by more than a token amount?
Twelve-month inflation has fluctuated in a narrow range since mid-year. It ticked upwards in November, from 7.9% to 8.0%. If our forecast for December is borne out, it will rise to 8.3%, which would be the highest measurement since June. Nevertheless, we expect it to decline relatively quickly after the turn of the year. Our preliminary forecast is as follows:
- January: CPI up 0.4% – headline inflation 7.8% – reflecting the offsetting impact of seasonal sales and increased public levies
- February: CPI up 0.8% – headline inflation 7.2% – with the CPI rise driven mainly by end-of-sale effects
- March: CPI up 0.5% – headline inflation 7.1% – with end-of-sale effects extending into March
As these figures show, headline inflation will fall briskly despite a continued rise in the CPI, as large monthly rises from H1/2023 drop out of twelve-month measurements. According to our long-term forecast, inflation will average 6.3% in 2024 and 3.9% in 2025.
Naturally, this forecast is highly uncertain. In the short run, house prices are the main uncertainty, plus the ISK exchange rate. The biggest question mark further ahead, however, is wage agreements, which are due to expire in rapid succession over the next few months.
This report is compiled by Islandsbanki Research of Islandsbanki hf.
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