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Inflation tenacious but will yield in the end

The outlook is for a 0.5% month-on-month rise in the CPI, and for inflation to measure 4.4% in September. The main drivers of the September increase are house prices and end-of-sale effects. Inflation is proving more stubborn than previously expected, but according to our forecast it will start to taper off gradually at the beginning of next year.

We project that the consumer price index (CPI) will rise by 0.5% month-on-month in September, and that twelve-month inflation will tick upwards to 4.4% from 4.3% in August. We expect inflation to rise slightly in coming months before starting to ease gradually at the beginning of 2022. House price inflation and foreign supply-chain disruptions are two of the main drivers of this persistence. We expect inflation to align with the Central Bank’s (CBI) target in Q4/2022. Statistics Iceland (SI) will publish the CPI for the month on 28 September.

House prices the main upward-pushing item

Rising house prices have made their mark on the CPI in recent months. Imputed rent, which reflects house prices to a large extent, has risen by 7.5% since March. According to our measurements, house prices will continue to rise at broadly the pace set in the past few months. We expect imputed rent to be the main upward-pushing item in September, rising by 0.9% MoM (0.15% CPI effect).

House price inflation continues unabated all over Iceland, with the twelve-month rise measuring just over 13% nationwide in August. As in the recent past, prices are rising fastest for single-family homes in greater Reykjavík (16%), followed by condominiums in greater Reykjavík (13%), while in regional Iceland, house price inflation has gained momentum, measuring 11% in August.

The CBI raised its policy rate last month, partly in a bid to cool off the real estate market, and the three commercial banks followed suit by raising their mortgage lending rates. In view of this, it will be interesting to keep abreast of market developments in coming months.

Other upward-pushing components

On the whole, clothing and footwear have had the same upward impact on the CPI as the housing component has during the past month. End-of-sale effects are the main reason for the rise, which tends to stretch into September, although this summer’s sales were quite shallow. We expect the clothing/footwear component to rise by 4.0% (0.15%) between months.

We also expect furniture and housewares prices to rise by 0.7% (0.05%) and food and beverage prices by 0.3% (0.04%), owing to the depreciation of the ISK in recent weeks.

Inflation more stubborn than anticipated but will fall in the end

The outlook is for inflation to remain above 4.0%, the upper deviation threshold of the CBI’s inflation target, for a while to come. According to our preliminary forecast, the CPI will rise by 0.3% in October, 0.2% in November, and 0.3% in December. If this forecast materialises, headline inflation will measure 4.4% in December. Thereafter, the outlook is for a steady decline, with inflation converging on the CBI’s 2.5% target in October 2022. According to our forecast, inflation will average 3.2% in 2022 and 2.7% in 2023.

This forecast is based on the assumption that the ISK will appreciate in coming quarters, as we expect it to do once tourist arrivals start to bounce back in earnest. If the ISK appreciates more than we anticipate, it will certainly speed up the disinflation process, but on the other hand, inflationary pressures from wages and/or house prices could turn out stronger than we assume, causing inflation to be more persistent in the coming term.

It is worth noting that the current inflationary episode is not unique to Iceland. Because of the pandemic, the price of a number of goods has soared. There are various explanations for this, chief among them the bottlenecks on the supply side. Price hikes abroad push the price of imported goods higher in Iceland as well, and if those price hikes continue, imported inflation could turn out higher than is forecast here.


Bergthora Baldursdottir




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