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Inflation easing in the right direction

The outlook is for headline inflation to subside in September – to 9.6%, if our forecast materialises. It is declining slowly but will start falling faster in 2023, as prompted by a cooler housing market and lower imported inflation.

We project that the consumer price index (CPI) will rise by 0.3% month-on-month in September, and that twelve-month inflation will fall marginally, to 9.6% from 9.7% in August. End-of-sale effects and rising food and house prices will be the main drivers of the increase in September, whereas lower airfares and petrol prices will be the main offsetting items.

Twelve-month inflation declined in August, for the first time since spring 2021. It appears as though inflation peaked in July, when it hit 9.9%, and is embarking on a downward trend – very slowly at first, and then more rapidly over the course of 2023. Statistics Iceland (SI) will publish the CPI for the month on 28 September.

Signs of a cooling housing market

House prices have persistently pushed the CPI upwards in the recent term. Twelve-month house price inflation nationwide measures 25%, its highest since 2006. It now looks as though the market has turned a corner and prices will rise much more slowly in the near future. The first signs of cooling came in July, when the house price index rose only 1.1% month-on-month. Imputed rent (largely a reflection of house prices) followed suit in August, rising only 0.9% according to the CPI measurement for the month. Both of these measurements are based on three-month moving averages, and both rose at a slower pace than at any time since year-end 2021.

We project that imputed rent will rise by only 0.6% MoM in September (0.12% CPI effect). If our forecast is borne out, it can surely be said that the housing market has finally begun to settle down, as imputed rent has not risen this slowly since December 2021 – and before that, since February 2021. We then expect the slowing trend to continue steadily over the months to come.

Food prices rise; airfares fall

The main upward-pushing item in September is food prices. We forecast that the food and beverages component will rise by 1.2% (0.18% CPI effect), with dairy products weighing heaviest. The agricultural pricing committee recently announced a 3.7-4.6% increase in the price paid to farmers for milk. The price hike took effect in September. These increases usually pass directly through to retail prices, and based on our measurement, there is no reason to expect that to change this time. Meat prices will rise as well, according to our measurements, and based on news from companies in the sector, they will probably rise still further in coming months.

Our measurements indicate that the end of seasonal sales is stretching into September, as end-of-sale effects were relatively mild in August. Clothing and footwear will rise in price by 3.2% MoM (0.10% CPI effect) and furniture and housewares prices by 1.5% (0.09%), according to our forecast. Other key items that look set to rise in price this month are recreation and culture (0.04% CPI effect) and other goods and services (0.03% CPI effect).

The main item offsetting these increases in September is the travel and transport component. We expect fuel prices to fall by 2.1% (-0.08% CPI effect). Global oil prices have fallen markedly in the recent past, which explains the drop in domestic petrol prices, although prices have fallen far less in Iceland than in other markets. Airfares generally fall in September, and this month should be no exception. The drivers of this month’s decline are lower fuel prices and the usual seasonal factors. We forecast that airfares will fall by 12.1% (-0.30% CPI effect) in September.

Trends are favourable, but the road ahead is long

We forecast that inflation will subside slowly in the near future. In our short-term forecast, we project that the CPI will rise by 0.3% in October, 0.2% in November, and 0.4% in December, and that headline inflation will measure 9.0% in December.

According to our long-term forecast, inflation will average 8.2% in 2022, 6.5% in 2023, and 3.9% in 2024. For our long-term forecast, we have updated the assumptions about inflation abroad, as the outlook is for inflation to be more persistent in both Europe and the US than was previously hoped. A stronger ISK will somewhat offset imported inflation, though. We also expect hefty pay rises in 2023, as the labour market is highly uncertain and this winter’s wage negotiations are likely to be contentious.

It goes without saying that there is a long road ahead, and much water yet to flow over the dam before inflation returns to the Central Bank’s (CBI) 2.5% target. But there is reason to hope things are moving in the right direction, and our September measurements support that hope. The outlook is for a calmer housing market, which will do much to defuse inflation in the coming term. That said, it is clear that other factors – such as imported inflation and domestic costs – must pull in the same direction so that inflation can fall faster and realign with the target within an acceptable time frame, although this is unlikely to happen during the forecast horizon.


Bergthora Baldursdottir




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