Marked drop in headline inflation in January

The CPI fell in January and was close to the lower end of the range projected by analysts. The measurement should stand the Central Bank (CBI) Monetary Policy Committee (MPC) in good stead when it meets next week. Airfares were the main downward-pushing item, while fuel prices pulled most strongly upwards.


According to newly published figures from Statistics Iceland (SI), the consumer price index (CPI) fell by 0.27% month-on-month in January, lowering headline inflation from 4.8% to 4.6%. Inflation excluding housing inched upwards from 2.8% to 3.0%, however, and the divergence between the two measures of inflation stem mainly from an unexpected drop in imputed rent. The January measurement is close to the low end of the range projected by financial market analysts, whose forecasts ranged between an unchanged CPI and a decline of -0.35%. We had forecast that the index would remain flat between months.

Fuel prices up, airfares down

Fuel prices were the single strongest upward driver in January, rising by 3.6% (0.13% CPI effect), largely because of an increase in carbon taxes and petrol and diesel fuel taxes. International airfares fell more than we had anticipated and proved to have the strongest downward impact on the CPI. Fares fell by 16.1% (-0.36% CPI effect), as they typically recede in January after the holiday-related spike in December. We expected a larger increase in bicycle prices after a change in value-added tax on them, but they rose by 13.5%, raising the CPI by 0.05%.

Imputed rent fell, in defiance of forecasts, while electricity and heating costs rose

As we see it, the big news in this month’s measurements is the drop in imputed rent, evidence of a cooling rental market. If the trend continues, inflation will be more likely to fall faster and align with the CBI’s inflation target earlier than recent forecasts have indicated. Imputed rent declined by 0.2% (-0.04%), whereas we had expected an increase of 0.6%. This is the first MoM decline in imputed rent since SI introduced its new calculation method last summer. Electricity and heating costs rose by 3.48% (0.11%), while we had projected an increase of 2.86%. The combined cost of housing, heat, and electricity therefore rose by 0.19% (0.06%).

Winter sales dampen the CPI, as usual

Clothing and footwear prices had the second-strongest downward effect on the CPI, falling by 6.9% (-0.26%). In addition, the price of furniture, furnishings, etc., declined by 4.6% (-0.23%) and electrical appliances by 9.5% (-0.11%). On the whole, the effects of seasonal sales were in line with our expectations.

Other items

Food and beverage prices rose by 0.61% in January (0.09% CPI effect), about twice as much as we had anticipated and twice as much as the Icelandic Federation of Labour grocery price index. Insurance prices were up 1.65% overall, driven mainly by a 4.07% increase in housing insurance costs. The jump in housing insurance prices is due largely to an increase in the premium paid to National Catastrophe Insurance (NTI), which is collected by insurance companies. It was announced that premium would rise steeply in order to rectify NTI’s financial position in the wake of the seismic activity on the Reykjanes peninsula. This spike in insurance costs had less impact than we had assumed, however, pushing the CPI upwards by a total of 0.016%.

Changes in Government levies on alcoholic beverages and tobacco products pushed upwards as well. Overall, the price of alcoholic beverages and tobacco rose by 3.9% (0.10%), with each of the two categories contributing 0.5% to the increase in the CPI.

The most important news is the drop in imputed rent, as the Housing and Construction Authority’s (HMS) rent price index also declined in December. This clearly indicates that the rental market is cooling, and if the trend continues, inflation will be more likely to fall faster and align with the CBI’s inflation target earlier than previously assumed. Our preliminary forecast is as follows:

  • February – CPI to rise 0.7% (twelve-month inflation 4.0%)
  • March – CPI to rise 0.4% (twelve-month inflation 3.6%)
  • April – CPI to rise 0.5% (twelve-month inflation 3.5%)

We expect inflation to move very close to target by mid-year, but if our forecast is to materialise, the exchange rate must be fairly stable and wage drift limited, and the housing market must develop as we have described above.

Analyst


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Birkir Thor Björnsson

Economist


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