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Inflation tumbles as the days grow shorter

Inflation has fallen markedly since the turn of the year and is heading steadily towards the Central Bank’s (CBI) inflation target. The housing market appears quite lively still, but house prices are rising broadly in line with the general price level at present. The near-term inflation outlook is good, and inflation could remain close to the CBI’s 2.5% target through 2021.

According to newly published figures from Statistics Iceland (SI), the CPI rose 0.09% month-on-month in September, lowering twelve-month inflation to 3.0% from the August measurement of 3.2%. Headline inflation has therefore fallen by 0.7 percentage points thus far in 2019, after measuring 3.7% last December. The CPI excluding housing rose by 0.10% during the month, and twelve-month inflation thus measured was 2.9%.

The September measurement is consistent with published forecasts. We had projected a MoM rise of 0.2%, whereas forecasts as a whole lay in the 0.1-0.2% range. The main difference between our forecast and the actual outcome lies in overseas airfares (which fell more than we expected) and paid rent (which declined unexpectedly), as well as in larger-than-projected declines in food and motor vehicle prices. On the other hand, clothing prices and imputed rent rose more than we had forecast.

Annual price list increases kick in, but other prices are down

The end of summer sales always affects the September CPI measurement. This time, clothing prices rose 4.2% (0.18% CPI effect) and furniture and housewares prices by 2.3% (0.12%). In addition, the recreation and culture component rose by 0.6% (0.06% CPI effect), owing both to the end of seasonal sales on television sets, computers, and like equipment, and to annual price hikes for athletic and recreational activities.

This was offset by marked declines in a number of index components, among them international airfares, which fell 8.6% (-0.13% CPI effect), quite a bit more than we had anticipated. In addition, motor vehicle prices fell by 1.1% (-0.06%), petrol by 0.9% (-0.03%), pharmaceuticals prices by 1.8% (0.03%), and food by 0.2% (-0.02%). All of these items are strongly affected by import prices. An unexpected development was the 0.6% drop in paid rent.

Buoyant activity in the housing market

The real estate market is quite a bit livelier than we would have expected, according to SI’s September measurements. House prices nationwide rose by 0.5% between months, although it should be noted that this measurement is based on a moving average with a one-month lag and, as such, reflects the average June-August price as compared with the May-July average. The increase was distributed more or less evenly across key subcomponents.

According to SI’s measurements, house prices have risen 3.3% in the past twelve months. The largest increase, 4.3%, is for detached housing in greater Reykjavík. Condominium prices have risen just over 3%, as have prices in regional Iceland. Real house prices are therefore virtually flat, as inflation is about the same, no matter whether the housing component is included or not.

Imputed rent, which is based on the above-mentioned measurement of market prices plus an interest component, rose by only 0.3% MoM in September. In essence, then, the interest component has had a significant downward impact on the measurement, reflecting recent improvements in terms for mortgage loans to individuals.

Inflation outlook relatively bright

The inflation outlook is quite good for the near term, and inflation looks set to fall back to the CBI’s 2.5% target before the year-end. We forecast that the CPI will rise 0.2% in October, 0.1% in November, and 0.5% in December, leaving headline inflation at 2.3% by the end of the year. As we stated in our most recent macroeconomic forecast, we expect it to average 2.6% in 2020 and 2.8% in 2021. According to this, inflation will align with the target before end-2019 and remain close to it for the rest of the forecast horizon.

If our forecast materialises, it will be easier for the CBI to mitigate the business cycle with appropriate interest rate adjustments. The main uncertainties in our forecast are the possibility of an ISK depreciation this coming winter, and the wage demands in still-pending labour market negotiations. On the other hand, developments in house prices could lead to lower inflation further ahead.


Jon Bentsson

Chief economist