In spite of the chaos in the markets and the depreciation of the ISK following the spread of the COVID-19 virus, the near-term inflation outlook is relatively favourable. We project that inflation will be below the CBI’s target throughout 2020, yet the possibility of a further weakening of the ISK is the main uncertainty in our forecast. Statistics Iceland (SI) will publish the March CPI at 9:00 hrs. on 27 March.

End-of-sale effects and house prices push the CPI upwards

The leading upward-pushing CPI component this month is clothing and footwear, which we expect to return more or less to pre-sale price levels. We project the rise in clothing and footwear prices at nearly 4.4% (0.19% CPI effect). According to our forecast, furniture and housewares will rise in price by 0.7% (0.04% CPI effect).

Apart from clothing and footwear, the housing component will have the strongest upward impact, according to our forecast. The housing component was a major factor in the February rise and will probably behave in a similar fashion this month, as the housing market still appears quite lively. Our forecasting model assumes that imputed rent, largely a reflection of house prices, will rise by 0.7% (0.11%).

Travel and transport component falls between months

The travel and transport component is set to fall by 0.24% between months (0.04% CPI effect). Petrol prices will fall, according to our forecast, as crude oil prices began to slide in early February and then dropped precipitously in early March, set off by the price war between Saudi Arabia and Russia. Presumably, the effects of the tumble in oil prices will affect the price of petrol in coming months, although oil companies generally have a few months’ worth of inventory on hand at any given time. We project the decline in March at 1.4% (0.05% CPI effect). We also expect airfares to hold more or less steady between months, although they usually rise somewhat in March. As can be imagined, airfares are difficult to predict at present.

Inflation below target, but the situation is highly uncertain

The near-term inflation outlook is reasonably favourable, although there is significant uncertainty about how the COVID-19 pandemic will affect the economy. We expect inflation to remain below target through this year but then rise slightly above it in 2021. We expect the CPI to rise by 0.3% in April, 0.2% in May, and 0.3% in June, bringing headline inflation to 2.0% in June.

We project that inflation will average about 2.2% this year and then rise in 2021, to an average of 2.6%. Uncertainty is unusually pronounced at present, especially as regards the ISK. Our forecast is based on the assumption that the exchange rate will hold relatively steady, but if it falls decisively, imported goods prices will rise more than was have projected here. Another assumption in our forecast is that the wage agreements still pending will be landed on terms allowing for moderate pay rises, with the contract between the City of Reykjavík and Efling labour union providing a favourable precedent.

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