The ISK has weakened by roughly 3% against the euro in the past month, and by nearly 21% in 2020 to date. It is beyond doubt that this year’s significant slide in the exchange rate is largely responsible for the rise in inflation over the past five months. What was surprising, though, was how long it took for the depreciation to pass through to inflation. The CBI is still active in the foreign exchange market, and its intervention has prevented the currency from weakening further, especially in the past few weeks. We forecast that inflation will average 2.8% in 2020, 2.8% in 2021, and 1.9% in 2022.
Inflation set to rise in September
We project that the consumer price index (CPI) will rise by 0.31% month-on-month in September, pushing headline inflation up to 3.4%, its highest since May 2019. Inflation will therefore remain above the Central Bank’s (CBI) inflation target of 2.5%, and we expect it to stay in above-target territory for the next several months.
We project a 0.31% rise in the CPI in September
ISK depreciation to play a key role
Petrol prices on track to keep climbing
Motor vehicle prices on the rise
Drug and pharmaceutical product prices increase between months
Price per square meter of condominium housing falls
Muted end-of-sale effects keep CPI rise in check
In recent years, summer sales in July and August have pushed the CPI downwards, but this year they had a far weaker effect, owing in large part to rising inflation in the past two months. We project that because of this weaker effect of seasonal sales, prices of home appliances and clothing will rise less this September than they have in recent years.
We expect airfares to drop in September, in line with the pattern of the past few years, and to weigh perhaps heaviest among downward-pushing CPI components, declining by 5% (0.08% CPI effect). The leading upward-pushing item is clothing and footwear, as new inventory bought at less favourable exchange rates is beginning to arrive in the shops after the summer sales. Other things being equal, we expect clothing and footwear prices to raise the index by 0.15%. Furniture and housewares will also rise somewhat in price, driven by the same factors as clothing and footwear. All that said, we expect furniture and housewares prices to rise more modestly this month than in September of the past few years.
Condominium prices fall between months
It is interesting to see that despite the current buoyancy of the real estate market, the per-square meter price of flats in multi-family dwellings has fallen nationwide, according to our price survey. After hitting a record ISK 45bn in June, net new lending contracted slightly, although it was still above average in July. Presumably, the real estate market is settling down somewhat after the bustle fuelled by low interest rates earlier in the year. We project that imputed rent will fall by 0.1% month-on-month (-0.02% CPI effect), the largest decline since May, when a large number of properties previously rented out were put on the market. Imputed rent is a composite item that takes account of house prices and developments in interest rates, and we project that house prices will push it downwards. This is a departure from the recent pattern, in which interest rates have tended to push downwards and house prices have pushed upwards.
Inflation set to remain above target in the coming term
The inflation outlook has been inching upwards in the past two months, since the ISK depreciation began to affect the domestic price level. It is difficult to predict how the ISK will behave in the near future, but what is clear is that the exchange rate will have a strong impact on inflation and inflation expectations. Nevertheless, as conditions in export sectors begin to improve, the medium-term uncertainty profile leans towards a rising real exchange rate, probably alongside a nominal appreciation of the ISK.
ÍSB Research is currently preparing a new macroeconomic forecast for publication later this month. The work on the forecast included updating the assumptions underlying our long-term inflation forecasting model, which results in a marginal upward shift in the inflation forecast for the coming year. Even so, we still expect inflation to ease back to the CBI’s target over time, and we assume that it will be slightly below target, on average, in the latter half of the forecast horizon.
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