Inflation on the wane

Inflation will ease steadily over the course of 2022, if our forecast materialises. January will be characterised by post-holiday sales, on the one hand, and increased public levies, on the other. In this instance, sale effects will have the upper hand. The outlook is for inflation to return to the Central Bank’s (CBI) target in H1/2023.


We project that the consumer price index (CPI) will fall by 0.2% month-on-month in January, and that twelve-month inflation will measure 5.0%, down from 5.1% in December. We expect inflation to taper off steadily this year and reach the CBI’s 2.5% target in H1/2023. Statistics Iceland (SI) will publish the CPI for January on 28 January.

Seasonal sales versus unit-based price hikes

January will feature the usual tug-of-war between post-holiday sales, on the one hand, and price list hikes and increased public levies, on the other. The effects of seasonal sales will weigh heavier this month, with furniture and housewares prices falling by 3.8% (-0.24% CPI effect) and clothing and footwear prices falling by 6.1% (-0.23% CPI effect), according to our measurements.

The travel and transport component is also set to decline by about 0.5% (-0.07%) MoM, with falling airfares and petrol prices offsetting rising motor vehicle prices. According to our forecast, airfares will fall by 7.15% (-0.11%) in January, following the usual post-holiday pattern after the 10% rise in December. Petrol prices will also fall marginally, or by 0.3% (-0.01%), despite the year-end rise in unit-based levies. The price of Brent crude fell in December, and our measurements suggest that the decline has passed through to the domestic price level. Prices abroad have started to rise again, however, and there is a strong likelihood that petrol prices will rise in February. Motor vehicles will rise in price by 0.6% (0.03%), mainly because of the year-end reduction in value-added tax subsidies for the purchase of plug-in hybrid cars.

Alcohol and tobacco products rose in price by 2.5% at the year-end because of hikes in unit-based levies, which will push the CPI upwards by 0.07%. Furthermore, as in previous months, the food and beverages component is set to rise, this time by 0.4% (0.06% CPI effect), and other goods and services are expected to rise in price by 0.6% (0.04%), partly due to an increase in public services prices.

House price inflation to lose pace

House prices rose by 16% in 2021, according to data from SI. Single-family home prices in the capital area rose most, or 18%, while house prices in regional Iceland rose 16.5% and condominium prices in the capital area by 15%.

The housing component still accounts for a large share of the rise in the CPI. In December, imputed rent rose by 0.6%, less than it generally did last year. We forecast a similar rise in January, with imputed rent up 0.7% MoM, perhaps indicating that the housing market is starting to cool off a bit. That said, various indicators imply that demand for housing is still very strong. Supply is limited and flats are selling quickly, many of them at a premium on the asking price. It will therefore be interesting to keep abreast of developments in the housing market in the months to come.

Inflation to lose steam in the new year

We believe that inflation may have peaked and a disinflation phase lies ahead, although inflation will taper off slowly at first. According to our preliminary forecast, the CPI will rise by 0.6% in February, 0.5% in March, and 0.4% in April. If this forecast is borne out, twelve-month inflation will measure 4.6% in April.

We still expect the ISK to appreciate this year, once tourists begin to visit Iceland again. Other assumptions underlying our forecast are that the housing market will settle down during the year as interest rates rise and supply firms up, and that the wage agreements up for negotiation towards the year-end will result in modest pay hikes. Moreover, we assume that the foreign supply-chain bottlenecks that have pushed imported inflation upwards will be resolved during the year. According to our forecast, inflation will average 4.3% in 2022, 2.5% in 2023, and 2.7% in 2024. If our forecast materialises, inflation will realign with the CBI’s 2.5% inflation target in H1/2023.

Author


Bergthora Baldursdottir


Economist

Contact

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