In recent years, the CPI has risen strongly in December, but this year we expect a more moderate increase. Inflation has been climbing steadily throughout 2020, owing in large part to the depreciation of the ISK, which has reversed to a degree since late November. We published an analysis of the causes of this recent appreciation of the ISK just a few days ago. In the past two weeks, the ISK has strengthened by more than 5%, but until that time it had weakened by about 12% since the beginning of the year. Pressure on the exchange rate appears to have eased temporarily, after a wave of large-scale currency purchases by foreign investors and record-breaking FX market intervention from the Central Bank (CBI) earlier this autumn. We forecast that inflation will average 2.8% in 2020, 2.9% in 2021, and 2.3% in 2022.

In recent years, airfares have been the main driver of the December rise in the CPI, but this time is indeed different. Icelanders have been accustomed to travelling abroad in December, particularly to include Christmas shopping trips. Obviously, though, there will be much less foreign mall-hopping in 2020, with COVID-19 upending travel plans for virtually the entire year. Airfares are forecast to rise by 2.8% (0.04% CPI effect) MoM, well below the five-year average December increase of 16.5% (0.19% CPI effect). All major components of the index push slightly upwards. Food and beverages are set to rise in price by 0.14% (0.02%), driven mainly by meat prices.

Inflation to hold fairly steady in the coming term

We project that the CPI will fall by 0.4% in January and then rise by 0.6% and 0.3%, respectively, in February and March. If our forecast materialises, inflation will remain relatively high in the coming term – averaging 3.7%, for instance, in Q1/2021. The outlook thereafter has improved markedly, however.

The brighter inflation outlook is due mainly to the prospect of more positive economic developments later in 2021, anchored by the past few weeks’ good news about COVID-19 vaccines and mass inoculation plans. In particular, the likelihood of a robust recovery in the tourism sector has increased. As a result, we have updated the exchange rate assumptions underlying our forecast to allow for a somewhat stronger ISK in the coming term. On the other hand, the outlook is now for a faster rise in house prices and wages over the forecast horizon. We project that inflation will be above the CBI’s 2.5% target in H1/2021 but fall below it by the end of the year. We expect inflation to average 2.9% in 2021 and 2.3% in 2022.

As is mentioned above, this month’s rise in the CPI is moderate in comparison with a typical December, not least because of the price hikes that have already come to the fore during the year. Inflation expectations have continued to improve MoM, however, and positive news about COVID-19 vaccines have boosted optimism in markets all over the world. Although the exchange rate pass-through from the ISK depreciation earlier this year gave inflation a boost, that episode is probably over by now, and inflationary pressures are likely to subside as next summer approaches. We expect inflation to rise marginally in the first few months of 2021 and then taper off quickly thereafter. Our forecast is based on two main assumptions: that a COVID-19 vaccine will be on the market in Q2/2021, and that the tourism industry will fare better next year than it has in 2020. The ISK will therefore appreciate over the course of 2021, and the slack in the economy will narrow at the same time.

LEGAL DISCLAIMER

This report is compiled by Islandsbanki Research of  Islandsbanki hf.

The information in this report originates in domestic and international information and news networks that are deemed reliable, along with public information, and Islandsbanki Research’s own processing and estimates at each time. The information has not been independently verified by Islandsbanki which therefore does not guarantee that the information is comprehensive and accurate. The views of the authors can change without notice and Islandsbanki holds no obligation to update, modify or amend this publication if assumptions change.  

This publication is only published for informational purposes and shall therefore not be viewed as recommendation/advice to make or not make a particular investment or an offer to buy, sell or subscribe to specific financial instruments. Islandsbanki and its employees are not responsible for transactions that may be carried out based on information put forth in the report. Before making an investment decision, recipients are urged to seek expert advice and get well acquainted with the investments market and different investment alternatives. There are always financial risks related to investment activities, including risk due to international investments and fluctuations in the exchange rate of currencies. Investors’ investment objectives and financial position vary. Past performance does not indicate nor guarantee future performance of an investment. 

The research report and other information received from Islandsbanki are meant for private use only. The materials may not be copied, quote or distributed, in part or in whole, without written permission from Islandsbanki.

This report is a short compilation and should not be considered to contain all available information on the subject it discusses. 

Supervisory body: The Financial Supervisory Authority of Iceland (www.fme.is).    

UNITED STATES

This report or copies of it must not be distributed in the United States or to recipients who are citizens of the United States against restrictions stated in the United States legislation. Distributing the report in the United States might be seen as a breach of these laws.

CANADA

The information provided in this publication is not intended to be distributed or circulated in any manner in Canada and therefore should not be construed as any kind of financial recommendation or advice provided within the meaning of Canadian securities laws.

OTHER COUNTRIES

Laws and regulations of other countries may also restrict the distribution of this report. 

Further information regarding material from Islandsbanki Research can be accessed on the following website: http://www.islandsbanki.is.