We project that the consumer price index (CPI) will rise by 0.2% month-on-month in January, lowering twelve-month inflation from 9.6% to 9.2%. Price lists and public levies will rise MoM, as is usually the case in January, and we also expect an increase in food prices. Offsetting these are seasonal sales and a drop in airfares. Inflation is highly likely to fall this year. The big question, though, is how fast. We forecast that inflation will measure 5.5% at the end of the year. Statistics Iceland (SI) will publish the CPI for the month on 30 January.
Inflation forecast: Inflation set to decline, but more slowly than previously forecast
Headline inflation will fall to 9,2% in January, according to our forecast. January will feature post-holiday sales, on the one hand, and increased public levies, on the other. In all likelihood, inflation will fall relatively quickly in 2023, albeit more slowly than previously assumed.
A host of year-end price hikes
Seasonal sales typically start in January, pushing the CPI downwards. According to our measurement, clothing and footwear prices will fall by 8.1% (-0.28% CPI effect) and furniture and housewares prices by 3.4% (-0.22%). Airfares will also decline after surging in December. According to our forecast, air transport prices will fall MoM by 9.6% (-0.22% CPI effect).
Other CPI components will push the index upwards during the month. All sorts of price hikes took effect at the turn of the year, including various price lists and public levies. Chief among them are alcohol and tobacco, which we expect to rise in price by 2.1% (0.05% CPI effect); motor vehicles, 3.5% (0.19%); petrol, 0.4% (0.01%); and other goods and services, 1.1% (0.07%).
Food prices set to rise in coming months
Our measurements also indicated a MoM increase in food prices. We forecast that food and beverage prices will rise by 1% (0.15% CPI effect), owing mainly to an increase in dairy product prices in the wake of the agricultural pricing committee’s announcement of an average 3.5% increase in the price paid to farmers, effective in January. Various food importers have announced price changes in January. According to our price measurements, other food prices did not change much during the month, but we expect further increases in February.
Food prices have soared worldwide since the pandemic struck. The FAO Food Price Index (FFPI) gives a useful indication of movements in global food prices in recent years. According to the index, food prices have climbed nearly 42% since the beginning of 2019, whereas Statistics Iceland’s (SI) measurements indicate that food prices in Iceland have risen 22% over the same period. These two metrics show clearly that prices have risen less in Iceland than in most of the rest of the world.
As the chart indicates, food prices have been much less volatile in Iceland. Price hikes probably reach Iceland with a lag, although this generally depends on firms’ inventories. Reports of rising food rices in Iceland probably stem from two sources: it takes time for price hikes abroad to reach Iceland, and the depreciation of the ISK has affected domestic prices. As we have discussed recently, the ISK is about 3% weaker than at the beginning of 2022.
According to the FFPI, global food prices peaked in March 2022 and have been tapering off since then. It will be interesting to see how prices develop in the coming term, both in Iceland and abroad. It is hoped that snarled supply chains and high shipping costs, a legacy of both the pandemic and the war in Ukraine, will soon be a thing of the past and that food prices will rebalance.
Housing market considerably cooler
The housing market appears to have been far more placid in the recent past, after a spate of steep price hikes early in 2022. Supply is growing, and tightened lending rules and higher interest rates have tossed a blanket over the flames. House prices have been bouncing around a bit, but we expect the market to be calmer in coming months.
According to our forecast, the housing component as a whole will increase by 0.9% MoM (0.28% CPI effect) and imputed rent by 0.5% (0.09%), mainly due to the interest component. As we have discussed previously, imputed rent is based on two underlying factors: house prices and an interest component, the latter of which is expected to cause imputed rent to keep rising in the coming term. The year-end increase in electricity and home heating prices will push the index up by 0.09%, according to our forecast.
Inflation set to decline – but more slowly than previously forecast
We are relatively optimistic about the next several months. Something big would have to change in order to prevent inflation from subsiding, as large monthly increases are set to drop out of twelve-month measurements. According to our forecast, the CPI will rise by 0.7% in February, driven mainly by end-of-sale effects and rising food prices. For both March and April, we expect MoM increases of 0.4%. If these projections materialise, inflation will measure 7.3% in April.
Nevertheless, inflation will ease somewhat more slowly than previously forecast. We project that inflation will average 6.9% in 2023. Naturally, there is pronounced near-term uncertainty, and a number of factors must line up if inflation is to fall quickly. To all appearances, the housing market has settled down, and it is vital for the inflation outlook that this should indeed be the case. The ISK needs to be more stable than it has been in recent months if imported inflation is to be kept under control. Another major uncertainty is the wage agreements that are still pending.
Author
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