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Inflation hits 16-month high

The consumer price index CPI rose by 0.39% month-on-month in September, pushing twelve-month inflation up to 3.5%, its highest since May 2019. After rising for six months in a row, headline inflation is now 1.0% above the Central Bank’s (CBI) inflation target, despite the CBI’s successful efforts earlier this year to keep it under control in the face of a steep drop in the exchange rate. Twelve-month inflation excluding housing is now 3.9%. Clearly, the housing component is still pushing inflation downwards, as it has in recent months.

The September measurement is slightly above our forecast, published earlier this month, of a 0.3% rise in the CPI. The furniture and housewares component increased more than we had projected, but with the buoyant housing market and the shift in consumption towards home improvement, we assume that consumers have bought more household items than usual, driving up demand and prices. Petrol prices were flat month-on-month after fluctuating widely earlier in the year. Private consumption has held its ground reasonably well in the recent term, after contracting sharply in Q2, when the ban on gatherings was at its most restrictive. Presumably, the price level is starting to show increased signs of exchange rate pass-through.

Furniture prices rise amid buoyant housing market activity

The greatest difference between our forecasts and Statistics Iceland’s (SI) figures lies in our underestimation of the increase in the price of furniture, housewares, etc. Furniture is a basic item accompanying home purchases, and first-time buyers now account for about 30% of total housing market demand. Most of these first-time homeowners have to buy a number of items, including furniture, for their new flats, thereby stimulating demand. It should also be borne in mind that the virtual collapse in overseas travel has given Icelandic consumers greater latitude to undertake indoor and outdoor home improvement projects. These factors have fuelled strong demand for furniture and housewares, which are now considerably more expensive than they were a year ago, thereby putting upward pressure on prices. The furniture and housewares item increased by 4% (0.22% CPI effect) between months, whereas we had forecast an increase of 2.3%. Petrol prices have fluctuated widely in 2020 to date, but this time they held steady between months, as global market prices have been broadly unchanged and the ISK has fluctuated within a relatively narrow band. The clothing and footwear component rose less than we had expected. Typically, new products arrive in stores at this time of year, pushing prices upwards, but this time the component rose only 1.75% (0.06% CPI effect), well below our forecast of a 4.2% increase.

Detached housing in greater Reykjavík leads house price increase

As is mentioned above, the real estate market has been lively in recent months, with a record ISK 45bn in net new mortgage lending during the month of June. Mortgage rates are at a historical low, giving demand a sizeable boost. Prices of single-family homes in the greater Reykjavík area rose most month-on-month (0.9%), albeit less than in the three months beforehand. Twelve-month house price inflation now measures 11.8% in regional Iceland and 7.3% in the capital area.

Imputed rent fell marginally in September (-0.01% CPI effect), driven mainly by the impact of falling mortgage rates on the component, which is a composite of movements in house prices and interest rates. Because interest rates have fallen so steeply in recent months, they have pushed strongly against the upward impact of house prices.

Inflation to hover around 3% in the near term

The near-term inflation outlook has deteriorated markedly in recent months. We forecast that the CPI will rise 0.2% per month in in October, November, and December, leaving headline inflation at 3.3% in October and 3.4% in November. That said, ÍSB Research does not consider the current inflation rate excessive, given the ISK depreciation earlier this year and the uptick in domestic costs. During the last recession (2008), for example, inflation averaged 12.6%.

As is usually the case, the outlook is highly uncertain. Nevertheless, the Icelandic economy stands on solid ground thus far and has the capacity to weather the current storm without suffering a protracted recession in international context. Further information on the comparison between Iceland and other countries can be found in our newly released Macroeconomic Forecast. The outlook is for inflation to start tapering off next year, as the days grow longer and summer approaches.


Tryggvi Snær Guðmundsson