We project that the consumer price index (CPI) will rise by 0.3% month-on-month in June, and that twelve-month inflation will measure 4.3%, down from 4.4% in May. We assume that inflation peaked at 4.6% in April and has begun a gradual downward trajectory. We expect it to align with the Central Bank’s (CBI) 2.5% inflation target in August 2022. Statistics Iceland (SI) is scheduled to publish the CPI for the month on 29 June.
Inflation to fall from 4.4% to 4.3%
The outlook is for a 0.3% month-on-month rise in the CPI, bringing headline inflation to 4.3% in June if our forecast materialises. As in recent months, house prices are the strongest upward-pushing CPI component in June. We think inflation has peaked for the present and has begun to taper off, albeit slowly, and we forecast that it will be at target by August 2022.
House prices continue to drive inflation
The housing market is buoyant at present, and rising house prices have made their mark on the CPI in recent months. The imputed rent component of the CPI has risen by 5.3% year-to-date, including 1.6% between April and May. Imputed rent is derived from housing market prices and mortgage interest, two variables that have been pulling in opposite directions recently. The market price of residential housing has risen by 7% YTD, yet at the same time, the mortgage interest component has pulled the imputed rent measurement down by 1.7%, owing to reduced mortgage lending rates.
We expect house prices to keep rising, but at a slower pace than in the recent past. Nevertheless, imputed rent will still weigh heavily in the June CPI measurement, rising by 0.80% MoM (0.13% CPI effect), according to our estimates. Demand pressures in the market remain strong, and we expect this to continue in the months to come. That said, we expect the pace of the rise to slow over the course of the year, in response to rising interest rates and an increase in housing market supply.
Other items affecting the CPI
The item that comes in second in terms of upward impact on the CPI is the travel and transport component. We expect it to rise by 0.60% (0.09% CPI effect), owing to a 4.2% MoM increase in airfares (0.07% CPI effect). But this item has proven resistant to predictions since the pandemic struck – in fact, it has risen by 4.6% in the past three months. We expect greater predictability in the coming term, once the air travel market rises from the ashes and international travel starts to normalise.
Apart from the housing and air travel components, the CPI is relatively quiet at present. The recreation and culture component pushes slightly upwards (0.02% CPI effect), as does the other goods and services item (0.02%).
Inflation to taper off slowly and steadily
We think inflation has peaked for the present and has begun to taper off, albeit slowly. We expect the CPI to remain unchanged in July, with summer sales offsetting house price inflation. We then expect it to rise by 0.5% in August and another 0.5% in September. If these projections materialise, inflation will measure 4.3% in September. We anticipate a quicker decline thereafter, with inflation reaching the target in August 2022. For the two years to follow, the outlook is for target-level inflation.
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 increase in earnest. On the other hand, the housing market is vibrant, and if house prices spiral out of control, inflation could become more firmly entrenched than we assume.
We are also concerned about various foreign goods prices, which have risen steeply, and about the pandemic-induced surge in shipping costs. For instance, commodities have been rising in price, and if the trend continues, domestic prices will follow suit, and inflation will be more persistent than we assume in our forecast.
This report is compiled by Islandsbanki Research of Islandsbanki hf.
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