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Inflation subsides to 9.5%

Twelve-month inflation fell from 9.9% to 9.5% in May, as we had forecast. We project that it will turn out to have peaked in February and will keep falling, perhaps quite quickly. A number of things must line up in order for this to happen, though: house prices need to stabilise, for instance, and imported inflation needs to ease.

According to newly published figures from Statistics Iceland (SI), the CPI rose 0.4% month-on-month in May, lowering headline inflation from 9.9% to 9.5%. Twelve-month inflation according to the CPI excluding housing fell, too, from 8.7% to 8.4%.The May measurement is consistent with our forecast. Overall, forecasts lay in the 0.3-0.6% range, including our own forecast of a 0.4% MoM rise in the CPI. This time there were no components that took us particularly by surprise.

Housing market erratic

Imputed rent rose 1.3% (0.25% CPI effect) during the month, driven by both the interest component and housing market prices. House prices rose by 0.6% MoM and the interest component by 0.7%, causing house price inflation to lose pace relative to April. We think the April surge in house prices was a temporary spike and that house price inflation will decline quickly in coming months.

The main cause of the increase in housing market prices can be found in regional Iceland, where prices rose by 1.7% from April to May and are up nearly 5% in the past two months combined. The market in greater Reykjavík has been calmer, with single-family home prices up 0.6% MoM and condominium prices by about 0.2%. The year-on-year rise in house prices nationwide continues to lose momentum, and now measures 10%.

Food prices up, airfares down

Apart from the housing component, food and beverage prices are the main driver of inflation this month. The food/beverage component increased by 0.8% (0.12% CPI effect), propelled mainly by higher bread, meat, and fruit prices. This month’s uptick is about the same as that in March and April, apart from the recent hikes in dairy product prices. We assume that the rise food and imported goods prices will lose steam in the next few months, in line with slower price increases abroad and the past few months’ decline in the price of certain commodities used for food manufacture.

Other key upward-pushing items in May were furniture and housewares, up 1.1% (0.07% CPI effect); hotels and restaurants, up 0.6% (0.03%); and other goods and services, up 0.7% (0.05%).

The travel and transport component is the only one to fall between months. The component as a whole fell by 1.3% (-0.20%), with all subcomponents contributing to the decline. Motor vehicles fell in price by 0.4% (-0.02%) and fuels by 1.8% (-0.06%), and airfares were down 6.1% (-0.14%), following their usual seasonal pattern after having risen over the previous two months.

Near-term inflation forecast

As is noted above, these inflation figures accord with our last forecast, and that forecast is therefore unchanged. We project that inflation will prove to have peaked in February and will subside in coming months. We forecast that the CPI will rise by 0.6% in June, 0.3% in July, and 0.3% in August, leaving headline inflation at 7.8% in August. For 2023 as a whole, we expect an average inflation rate of 8.7%.

Naturally, the situation is highly uncertain, and a number of factors must be in sync if inflation is to fall quickly. First off, the housing market must hold stable and imported inflation must decline. These two wishes are more likely than not to be granted, however: the housing market looks set for a tranquil period, and trading partner inflation is falling – and rather rapidly in some cases.

Although inflation could fall swiftly in coming months, the journey back the Central Bank’s (CBI) 2.5% inflation target is a long and arduous one. We do not expect inflation to align with the target during the forecast horizon. According to our long-term forecast, it will average 5.3% in 2024 and 3.7% in 2025.


Bergthora Baldursdottir