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Inflation falling faster than anticipated

A negligible rise in house prices and plunging airfares are the main reasons for the smallest month-on-month rise in the CPI in nearly two years. The short-term inflation outlook has improved somewhat, although inflation is expected to remain high in the coming term.

According to figures released recently by Statistics Iceland (SI), the CPI rose by only 0.1% month-on-month in September, the smallest increase in the index since January 2021. Headline inflation therefore measures 9.3%, down from 9.7% in August. Twelve-month inflation according to the CPI excluding housing measured 7.0% during the month.

The September measurement was below all official forecasts, which had provided for a rise in the CPI ranging from 0.2-0.4 percentage points MoM. Our own updated forecast assumed a rise of 0.2%. The main difference between our forecast and SI’s measurements lies in airfares, which fell more than we had anticipated.

Housing market cooling rapidly

According to SI’s measurement, the housing component rose by 0.2% MoM (0.06% CPI effect), owing mainly to a 0.7% increase in paid rent (0.03% CPI effect). On the other hand, imputed rent, largely a reflection of house prices, rose by only 0.05% (0.01%), the smallest increase recorded since November 2020, when it fell marginally.

House prices were flat MoM, according to SI data, with capital area single-family home prices rising 1.1%, while condominium prices in the capital area were unchanged. Prices in regional Iceland fell by 0.9% MoM.

House price inflation is finally losing steam. In the past twelve months, prices have risen by 22.6% nationwide, down from 25% in August. The increase has been fastest in regional Iceland, at 23.6%, followed by multi-family homes (22.9%) and single-family homes (20.7%) in the capital area.

As these figures show, the market is cooling, and at a good clip. On the whole, SI’s measurements chime in with house price index data published last week, although the two sets of figures differ somewhat as regards the price of detached housing. Both sets of data are based on three-month averages, suggesting that August was a very calm month in the housing market.

End-of-sale effects versus plunging airfares

Summer sales generally take place in July and end in August and September. Clothing and footwear rose in price by 4.6% MoM (0.15% CPI effect) and furniture and housewares prices by 2.2% (0.14%). In addition, food and beverage prices rose 0.3% MoM (0.05%), which was less than we had expected. This month’s uptick in food prices was due entirely to the agricultural pricing committee’s announced increase in wholesale prices, which passed more or less straight through to retail prices. There was little movement in the price of other foods, many of which are imported and had already risen steeply in price in recent months. This is exceedingly welcome news.

Other items that rose in price this month are recreation and culture, up 0.8% (0.07% CPI effect), and other goods and services, which rose 0.9% (0.07%).

The main item offsetting these increases is the travel and transport component. The component as a whole declined 2.8% (-0.44% CPI effect), with fuel prices falling by 2% (-0.08%) and air travel falling by 17% (-0.43%). It is good to see airfares fall so markedly between months – something they have not done since September 2018. Airfares generally decline in September, after rising during the summer. In July, for instance, they surged 35% July, but much of that increase has now reversed, presumably because of seasonal factors and lower fuel prices.

The outlook is favourable, but there is a long road ahead

Inflation is definitely moving in the right direction, but the road ahead is long, and bringing it back to the CBI’s 2.5% target will take time. The housing market looks set to be calm in the coming term, and imported inflation is likely to be lower, making for a fairly swift drop in headline inflation in the near future.

We forecast that the CPI will rise 0.2% in October, 0.1% in November, and 0.4% in December, and that headline inflation will measure 8.6% in December. This a marginally faster decline in inflation than we had previously projected.

According to our long-term forecast, inflation will average 8.1% in 2022, 6.2% in 2023, and 3.9% in 2024. The main assumptions underlying this forecast are that the housing market indeed turns out to be cooling rapidly and that imported inflation proves lower than in the recent term. We also assume that a stronger ISK will offset imported inflation to a degree. One of the main uncertainties is the upcoming round of wage negotiations. Contracts expire this winter, and the labour market is highly uncertain, making it likely that negotiations will be contentious.


Bergthora Baldursdottir