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Inflation tips the scales at 5.7%

The CPI rose by 0.5% in January, in defiance of forecasts. Headline inflation now measures 5.7%, its highest since April 2012, and is driven mainly by house prices and imported inflation. We are still of the opinion that inflation will ease this year, although the disinflation episode will start gradually.

According to newly published figures from Statistics Iceland (SI), the CPI rose 0.5% month-on-month in January, pushing inflation up to 5.7% from the December figure of 5.1%. This is Iceland’s highest inflation figure since April 2012. Twelve-month inflation excluding housing is now 3.7%.

The January measurement is well above our projections and those of other forecasters. All official forecasts had provided for a 0.2% MoM rise in the CPI. The main differences between our forecast and SI’s measurements lie in imputed rent, which rose significantly more than we had expected, and in motor vehicles and food and beverages, which also rose more than we had projected.

Housing market still going strong

In keeping with the recent pattern, the housing component was the main driver of this month’s rise in the CPI. The component as a whole rose by 1.6% (0.5% CPI effect). Of that amount, imputed rent rose 1.5% (0.25% CPI effect), and electricity and heat rose in price by 3.7% (0.11% CPI effect) due to tariff increases that took effect at the turn of the year.

Imputed rent is based largely on SI’s calculation of housing market prices based on registered purchase agreements for the October-December period. In the past year, house prices nationwide have risen by 16.7%, according to SI figures, with single-family homes in greater Reykjavík up 18.8%, housing in regional Iceland up 16.7%, and capital area condominium prices up 15.3% in the past twelve months.

In our recently published macroeconomic forecast, we projected that house prices would rise by 8% this year. Conditions are in place for a continued increase, but the pace looks set to ease with further policy rate hikes and increased supply later in the year.

Imported inflation versus seasonal sales

It can be said that the housing component plus imported inflation and tariff increases outweighed the impact of seasonal sales, in defiance of our forecast. The component that rose most apart from housing was food and beverages, which increased by 1.3% (0.2% CPI effect). This can be attributed to the pandemic, as prices abroad have risen steeply, owing in part to supply shortages and increased shipping costs, which have pushed imported food prices sharply upwards. By the same token, the travel and transport component rose by 0.8% (0.10%), mainly because of a 2.2% increase in motor vehicle prices (0.11% CPI effect). Car prices have risen abroad as well, but the increase in Iceland also reflects the reduced Government subsidy for purchases of plug-in hybrids.

We found it noteworthy that air transport prices fell by only 0.4% MoM, in spite of a steep rise in December. Airfares typically fall in January; in fact, over the past five years they have fallen by an average of 7.3%.

Even though the CPI rose significantly MoM, winter sales had a dampening effect. The largest decline was in clothing and footwear prices, down 8% (-0.30%), followed by furniture and housewares, down 2.7% (-0.17%).

Inflation not a uniquely Icelandic concern

Iceland certainly does not have a monopoly on inflation these days. In the OECD, for instance, inflation averaged 5.8% in November 2021. Most countries are battling the same problem in the wake of the pandemic, as the chart indicates.

Inflation to taper off, albeit slowly

We are still of the opinion that inflation will decline this year, although the disinflation episode will start gradually. According to our preliminary forecast, the CPI will rise by 0.6% in February, 0.5% in March, and 0.4% in April. If these projections materialise, inflation will measure 5.3% in April. Thereafter, we expect further disinflation as the ISK appreciates, the housing market rebalances, and foreign markets for production and shipping of consumer goods normalise once again. We also expect sizeable pay rises during the period, although we project that the wage negotiations slated for the end of this year will result in relatively modest increases.


Bergthora Baldursdottir