House price inflation falls to eight-year low

Imputed rent, which is by and large a reflection of developments in house prices, rose by 0.27% in July (0.04% CPI effect). The market price of residential housing rose by 0.43% between months, however. This was because the interest component of imputed rent had a strong downward effect this time, in response to the recent drop in mortgage lending rates. The interest component is based on a twelve-month moving average of mortgage rates.

The month-on-month rise in house prices was confined largely to regional Iceland, where prices rose by an average of 1.3% between June and July. In the capital area, condominium prices rose only 0.3% MoM, while detached housing fell in price by 0.1%.

According to SI figures, twelve-month house price inflation now measures 3.5%, the lowest in over four years and the equivalent of only 0.4% in real (CPI-adjusted) terms. Prices in regional Iceland have risen by 4.9% in the past year. In greater Reykjavík, condominium prices are up 3.5% since July 2019 and detached housing prices by only 2.4%. The latter have therefore fallen in real terms by 0.7% in the past year.  There has been a major shift in house price developments since end-2018, when twelve-month house price inflation measured 6.9% in nominal terms and 3.2% in real terms.

Seasonal sales effects as expected

The effect of seasonal sales on consumer prices in July was broadly in line with our expectations. The clothing and footwear component declined by 11.2% during the month (-0.49% CPI effect), and furniture and housewares fell in price by 3.5% (-0.19%). In addition to these items, most of which fell as a result of seasonal sales, petrol prices declined by 0.39% (-0.01% CPI effect).

Modest rise in airfares

The travel and transport component as a whole rose by 1.1% (0.16% CPI effect), led by a 4.98% increase in air transport prices (0.09%). Airfares have a tendency to spike over the summer, and this month’s rise is unusually moderate. Over the past five years, for instance, the average July increase has been 21%. Another item falling under the travel and transport component, motor vehicles prices, rose by 1.1% (0.06%).

Other items that rose in July were hotel and restaurant services, up 1.86% (0.11%), and food and beverages, up 0.59% (0.08%).

Inflation set to ease

We forecast that the CPI will rise by 0.3% in August, 0.3% in September, and 0.3% in October,  lowering headline inflation to 3.0% in October.

End-of-sale effects will make an impact on the CPI in August and September, but we expect this to be offset to a degree by a seasonal drop in airfares. Thereafter, we expect inflation to ease in Q4/2019, measuring 2.7% — within striking distance of the CBI inflation target — at the year-end. We then expect it to measure 2.8% at the end of both 2020 and 2021.  There are two main uncertainties in our forecast: a possible depreciation of the ISK and wage demands in still-outstanding labour market negotiations. On the other hand, developments in house prices could lead to lower inflation than we have forecast here.