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House prices the leading driver of higher inflation in October

The housing component accounts for almost half of the nearly 0.6% increase in the CPI in October. House price inflation shows no sign of abating, but even so, inflationary pressures stem from a number of factors at present. The short-term inflation outlook has deteriorated in recent months, but it still appears that inflation will fall back to the Central Bank’s (CBI) target by the end of 2022.

According to newly published figures from Statistics Iceland (SI), the CPI rose 0.59% month-on-month in October, raising twelve-month inflation from 4.4% in September to 4.5%. The CPI excluding housing rose by 0.47% during the month, however, and twelve-month inflation thus measured was 3.0%. The numbers show both that there is a significant difference between inflation with and without the housing component, and that inflationary pressures are rather widespread at present.

The October measurement is at the upper end of official forecasts. We had projected a rise of 0.5% between months, whereas forecasts as a whole lay in the 0.5-0.6% range. The difference between our forecast and SI’s measurement lies mainly in the housing component – both imputed rent and home maintenance – and the furniture and housewares component, both of which rose more than we had projected. On the other hand, airfares fell markedly month-on-month, contrary to our expectations.

Inflation driven strongly by the housing component

In October, as in recent months, the housing component was the leading driver of the rise in the CPI. It rose overall by nearly 0.9% (0.28% CPI effect), accounting for nearly half of the total MoM rise in the index. Within the housing component, the main contributor was imputed rent, which was up 1.4% since September (0.23% CPI effect). The home maintenance subcomponent rose as well, by 0.8% (0.05%), while paid rent was flat between months, according to SI’s measurements.

Imputed rent is by and large a reflection of developments in house prices, and SI publishes its house price measurements concurrent with the CPI. The MoM increase in house prices was greatest in regional Iceland (2.7%), whereas detached housing and condominiums in greater Reykjavík rose in price by 0.8% and 1.1% MoM, respectively.

In the past twelve months, house prices nationwide have soared 15.1% according to SI data, the fastest year-on-year rise in four years. The price of detached housing in greater Reykjavík has led the way (18.8%), followed by capital area condominiums and housing in regional Iceland, at 14% each. As yet, inflationary pressures from the housing market show no signs of letting up, and it will be interesting to see whether interest rate hikes and tighter rules on debt service ratios, announced by the CBI this autumn, will cool the market down in the weeks and months to come.

Inflation lurks in many places

Although the housing component explains a large share of this month’s rise in the CPI, inflationary pressures can be found in many other components of the index. Imported goods are relatively prominent in this respect. Petrol prices, for instance, rose 4.2% MoM (0.13% CPI effect), the largest single-month increase in 6 1/2 years. This increase stems from global oil prices, which have skyrocketed year-to-date and gained even further momentum this autumn.

Other sources of pressure include furniture and housewares, up 1.3 MoM (0.09%); clothing and footwear, up 1.0% (0.04%); and food, up 0.4% (0.06%).

MoM price reductions were few and far between in October, although airfares fell 3.6% (-0.05%).

The composition of inflation has changed markedly in the past year, as the chart below indicates. The housing component has taken over from imported goods as the chief cause of inflation. Of the 4.5% headline inflation figure for October, 2.0% stems from housing, 1.1% from domestic services, 1.0% from imported goods, and 0.4% from domestic goods.

But inflation excluding housing – which, at 3.0%, is also above the CBI’s 2.5% target – shows that the housing component is far from the only culprit at the moment. For example, public services have risen in price by 3.4% in the past year, other domestic services by 3.7%, imported goods by 3.0%, and domestic goods by 2.9%. As these numbers show, inflation is caused by a range of factors at present, although the housing market is certainly the main driver.

The short-term inflation outlook has deteriorated

The near-term inflation outlook has deteriorated steadily in recent months, and the same is true for October: house price inflation shows no sign of giving way, and the full impact of rising input prices and shipping costs abroad has yet to come to the fore.

According to our preliminary forecast, the CPI will rise by 0.3% in November and 0.4% in December, and then fall by 0.2% in January. If this forecast is borne out, twelve-month inflation will measure 5.0% at the end of 2021 and ease to 4.8% in January. Thereafter, we expect the appreciation of the ISK, greater price stability and possible reductions in various imported goods prices, and a slower rise in house prices to contribute to disinflation over the course of 2022. But it looks as though inflation will not return to the CBI’s 2.5% target until Q4. Whether it remains at target in 2023 and beyond will depend not least on the outcome of the wage negotiations set for late 2022, and whether the housing market can be stabilised over time.


Jón Bjarki Bentsson

Chief economist