Inflation dips unexpectedly in December

Inflation took a surprise dip in December, mainly because house prices and airfares rose less than expected. The slide in headline inflation began a month earlier than we had anticipated, but we expect it to continue on the months to come.

According to newly published figures from Statistics Iceland (SI), the CPI rose 0.4% month-on-month in December, lowering headline inflation from 8.0% to 7.7%. Twelve-month inflation according to the CPI excluding housing is down as well, to 6.7%.

The December measurement is below all official forecasts, which lay in the 0.6-0.9% range, including our own forecast of a 0.9% rise in the CPI. The big surprises in the December measurement showed in house prices and airfares, both of which fell considerably more than we had expected.

Housing market settles down once again

The main driver of the December rise in the CPI is imputed rent. House prices have been a major contributor to inflation in the past several months, but this month the situation looks quite different, as property prices have risen far less than in the recent past. Imputed rent rose by 0.85% (0.17% CPI effect), the smallest monthly increase since August. Imputed rent is a composite measure of housing market prices plus an interest component based on indexed mortgage rates. House prices rose by 0.34% this month, and the interest component increased by 0.5%. Housing market prices are well in line with the house price index, which rose by only 0.1% according to the latest data, published this week.

Year-on-year house price inflation has gained pace slightly in recent months and currently measures 4.2%. Even so, this is a radical shift from the situation in summer 2022, when the twelve-month rise in prices peaked at 25%. In the past year, the price of housing in regional Iceland has risen the most, at 8%. Next in line are capital area condominium prices, up 3.1% in the past year, followed by detached home prices in the capital area, which have increased by 2% over the same period.

Other drivers of the CPI rise

Apart from housing, the travel and transport component is the main driver of inflation. It rose by 0.7% (0.10% CPI effect), as fuel prices fell 0.8% (-0.02%), while airfares rose 5.5% (0.09%). It is noteworthy how little airfares have risen this month, as they usually show double-digit increases in December. As the chart below indicates, the main reason the CPI increased less this month than we had forecast is that house prices and airfares have risen less than we anticipated.

Other key upward-pushing items in December are other goods and services, up 1% (0.07% CPI effect); health, up 1% (0.04%); and clothing and footwear, up 0.9% (0.04%).

Two items declined between measurements: furniture and housewares, which fell 1.3% (-0.08%), owing mainly to a drop in electronic equipment prices, and postal and telephone services, which fell for the fourth month in a row, this time by 1.1% (-0.02%).

The inflation outlook

These most recent inflation figures are good news indeed. Inflation is falling faster than we had assumed, and the average for the year looks set to clock in at 8.7%. We expect it to keep tapering off in coming months, and quite quickly at that. We have revised our housing market forecast for the next few months, as we now think the recent price hikes will start to lose steam. Nevertheless, this does not change our preliminary forecast to any radical degree. According to our preliminary forecast, the CPI will rise 0.4% in January, 0.8% in February, and 0.5% in March. If this forecast is borne out, twelve-month inflation will measure 6.6% in 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 5.8% in 2024 and 3.7% in 2025. The main short-term developments needed for our forecast to materialise are a tranquil housing market and a more stable ISK than we saw this past autumn. In the longer term, the main uncertainty centres on the labour market and what kind of wage agreements are reached early next year.


Bergthora Baldursdottir