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Obstinate inflation driven mainly by house prices

This month’s rise in the CPI was due largely to house price inflation – as has been the case more often than not in past several months. Headline inflation now measures 4.4%, somewhat above the upper deviation threshold of the Central Bank’s (CBI) inflation target. We expect it to remain close to that upper threshold in coming months and then start to give way early in 2022, aligning with the CBI’s 2.5% in the latter half of next year.

According to figures released recently by Statistics Iceland (SI), the CPI rose 0.47% month-on-month in September, bumping twelve-month inflation up to 4.4% from the August measurement of 4.3%. Twelve-month inflation excluding housing is now 2.9%.

The September measurement is well in line with our forecast of a 0.5% MoM rise in the CPI. The main difference between our forecast and SI’s measurements is the housing component, which rose more than we anticipated, whereas international airfares declined, which we had not expected.

Autumn is here, but the housing market retains its summertime buoyancy

Imputed rent, which is mainly a reflection of housing market prices, was the item in the September CPI measurement that took us most by surprise, rising by 1.7% MoM. Once again, the residential property market appears more resilient than most observers expected based on SI’s house price measurements. Prices overall rose by 1.75% MoM. Detached home prices in greater Reykjavík rose the most (2.7%), while the price of capital area condominiums and housing in regional Iceland increased by about a percentage point and a half.

In the past twelve months, house prices nationwide have risen by 14.7%, the fastest pace since year-end 2017. Single-family homes in greater Reykjavík have appreciated most (18.2%) in the past year, followed by condominiums (14.5%) and housing in regional Iceland (12.2%).

It is worth noting that this month’s measurement includes purchase agreements made in June-August and therefore does not reflect the impact of the CBI’s policy rate increase in late August. It will be interesting to see whether that rate hike and the Monetary Policy Committee’s (MPC) relatively stern tone concerning the possibility of additional rate hikes will put a damper on housing market activity. What is more likely, though, is that the market will remain ebullient for a while to come.

Various components push upwards

Apart from the housing component, the clothing and footwear component was the strongest upward-pushing CPI item in September. It rose by 4.1% (0.15% CPI effect), owing to end-of-sale effects that stretched beyond the August CPI measurement. The food and beverages component increased by 0.50% (0.07%) MoM, with fruit and vegetables prices leading the way – perhaps because of the recent surge in global shipping costs, among other factors.

Other items that rose in price this month are recreation and culture, up 0.4% (0.04% CPI effect), and other goods and services, which also rose 0.4% (0.03%).

Airfares push downwards

The travel and transport component fell by 0.5% between months (-0.07% CPI effect), reflecting the offsetting impact of airfares versus motor vehicles and petrol prices. International airfares fell 7% MoM (-0.10%) and have now declined by 9% in the past two months combined. Presumably, the drop in prices is due to the Delta variant of COVID-19 and its impact on appetite for travel, although seasonal factors may also be at play. This was offset, though, by motor vehicle prices, which rose 0.3% (0.02% CPI effect), and petrol prices, which rose 1.1% (0.03%). The price of petrol has now risen 14.4% year-to-date, reflecting the surge in global oil and fuel prices thus far in 2021.

Other components that declined MoM are furniture and housewares, which fell 0.5% (-0.03%), and postal and telephone services, which fell 1.9% (-0.03%).

The outlook for the months ahead

The outlook is for inflation to remain close to 4.0%, the upper deviation threshold of the CBI’s inflation target, for a while to come. According to our preliminary forecast, the CPI will rise by 0.3% in October, 0.2% in November, and 0.3% in December. If this forecast materialises, headline inflation will measure 4.4% in December and decline steadily thereafter. We project that it will finally converge with the CBI’s 2.5% target in Q3/2022 and then remain close to target from then on.

This forecast is based on the assumption that the ISK will appreciate in coming quarters. As we have mentioned previously, we expect the ISK to gain strength as tourist numbers pick up. On the other hand, house prices are still rising unabated, and if the situation persists, they will contribute to higher and more stubborn inflation. Furthermore, inflation could be harder to dislodge if wage rises are excessive, although uncertainty on this score has subsided with the recent confirmation that the Living Standards Agreement will remain in effect until Q4/2022.

We are also quite concerned about imported inflation at the moment. Because of the pandemic, the price of a number of goods has soared, as have shipping costs. Steep price hikes abroad will push imported goods prices upwards even if the ISK appreciates, and if those price hikes continue, imported inflation could turn out higher than we have assumed here.


Bergþóra Baldursdóttir



Jón Bjarki Bentsson

Chief economist