Inflation to end the year on a high note … and then start to settle down

Inflation will peak in December and then start tapering off gradually, if our forecast materialises. Housing and food and beverages will be the main drivers of this month’s increase. The outlook is for inflation to return to the Central Bank’s (CBI) target in Q1/2023.


We project that the consumer price index (CPI) will rise by 0.4% month-on-month in December, and that twelve-month inflation will measure 5.0%, up from 4.8% in November. This would be Iceland’s highest inflation measurement in more than nine years. We expect inflation to peak in December and then subside steadily until it reaches the CBI’s 2.5% target in Q1/2023. Statistics Iceland (SI) will publish the CPI for the month on 21 December.

House prices still climbing

As in recent months, house prices are the main driver of the rise in the CPI in December. The housing component as a whole will increase by 0.6% (0.19% CPI effect), according to our forecast, As before, imputed rent will rise the most, although the subcomponent for home maintenance and repair will increase as well, by 0.8% (0.04% CPI effect). The maintenance and repair item is linked directly to the building cost index, which has risen somewhat in the recent term.

Imputed rent, which to a large extent is a reflection of developments in house prices, has risen over 12% thus far in 2021. We expect it to maintain the current pace in December, increasing by 0.8% MoM (0.13% CPI effect), although this is a slightly slower rise than we have seen in recent months. It could be that higher interest rates and other CBI measures have begun to affect the housing market.

Other upward-pushing components

Apart from the housing component, food and beverages are expected to rise the most between months. We expect an increase of 0.8% (0.12%), owing mainly to higher wholesale prices for milk and dairy products following the Agricultural Pricing Committee’s recently announced price hike, which took effect on 1 December.

Other key items set to rise between months are furniture and housewares, up 0.5% (0.04% CPI effect), and clothing and footwear, up 0.7% (0.02%). The travel and transport component is also set to increase by about 0.14% (0.02%) MoM, with falling petrol prices offsetting rising airfares and motor vehicle prices. Petrol has risen in price by more than 20% year-to-date but will fall by 1.0% (-0.03%) this month, according to our measurement. This accords with developments in fuel prices abroad, as the price per barrel of Brent crude began falling in late November and is now 13% below its recent peak. Nevertheless, petrol prices have begun climbing again, as the chart indicates.

Inflation outlook clearing up

The short-term inflation outlook has improved marginally since our last forecast, but even so, inflation will remain high in coming months. There appears to be no end in sight to the price pressures in the housing market, and price hikes abroad are still sizeable. According to our preliminary forecast, the CPI will decline 0.2% in January and then rise in February and March, by 0.6% and 0.4%, respectively. If this forecast is borne out, twelve-month inflation will measure 4.6% in March.

We still expect the ISK to appreciate in 2022. Our forecast is also based on the assumption that house price inflation will ease and that imported goods prices will rebalance. Inflation will then start to taper off gradually, aligning with the CBI’s target in Q1/2023. According to our forecast, it will average 3.9% in 2022 and 2.6% in 2023. In our long-term forecast, we also assume that wage hikes will average 7% in 2022. Wage agreements will be up for negotiation late next year, and if the resulting pay rises are larger than we have assumed, inflation will turn out more persistent than we have forecast here.

Author


Bergthora Baldursdottir


Economist

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