A recalcitrant housing market

Imputed rent rose 1.6% (0.31% CPI effect) during the month, driven by both the interest component and housing market prices. House prices rose by 1.0% MoM and the interest component by 0.6%.

Activity in the housing market is quite brisk despite the past few months’ steep interest rate hikes and more stringent mortgage lending requirements. The main cause of the increase in housing market prices can be found in single-family homes in greater Reykjavík and housing prices in regional Iceland. Detached housing in the capital are rose 1.8% MoM and property in regional Iceland by 1.7%. Prices in regional Iceland have risen 6.4% in the past three months. Price hikes are smallest for condominium housing in the capital area, which rose by 0.4% MoM. Even though the housing market remains lively, twelve-month house price inflation continues to ease. It now measures 7.9% nationwide, down from nearly 25% a year ago.

Most components push upwards

Apart from housing, the recreation and culture component was the main driver of inflation in June, rising by 1.5% (0.15% CPI effect), owing mainly to package tours and recreational goods. Hotel and restaurant services rose in price by 2.7% MoM in June (0.14% CPI effect), propelled mainly by accommodation prices, which jumped by 17% in a typical manifestation of the seasonal pattern, as the tourist season is approaching its peak. Nevertheless, this is a larger increase than is generally seen in June.

Food and beverages rose in price by 0.5% (0.08%) MoM, the smallest monthly increase since September 2022. We hope this is a sign that food price inflation will moderate in the coming term, as prices abroad are generally rising more slowly these days. In a noteworthy development, the travel and transit component rose by only 0.65% (0.10%), driven mainly by a 2.4% rise in airfares (0.05% CPI effect). Airfares usually rise much more than this in June, as the peak tourist season is on the doorstep. That being the case, airfares could well rise sharply in July.

Downward-pushing items in June are furniture and housewares, which fell by 1.3% (-0.08%), and postal and telephone services, which are down 1.6% (-0.03%).

Disinflation set to continue in the near future

Fortunately, an examination of inflation by nature and source shows that most items’ contribution to headline inflation is on the wane. Imported inflation receded the most as a driver of inflation, accounting for 1.9% at present. The housing component continues to contribute the most to the headline rate, accounting for 2.9% of twelve-month inflation. The contribution of domestic goods has shrunk slightly, to 1.5%, while the contribution from services has increased MoM, to 2.6%.

Inflation is finally falling at a fairly swift pace and is now below 9% for the first time in a year. We are relatively optimistic about the months to come. We expect inflation to keep subsiding, quickly at first and then more gradually in the autumn. We forecast that the CPI will rise by 0.4% in July, 0.3% in August, and by 0.4% in September, lowering headline inflation to 8.4% in September. This is a slightly slower disinflation rate than we had previously anticipated, as the June CPI rise exceeded our forecast. We project that inflation will average 8.9% in 2023 as a whole.

Naturally, the situation is highly uncertain, and a number of factors must work together if inflation is to fall quickly. First of all, the housing market must cool down, and imported inflation must continue to fall. The Central Bank’s inflation target is still quite distant, and we do not expect inflation to realign with it during the forecast horizon. According to our long-term forecast, inflation will average 5.3% in 2024 and 3.6% in 2025.