The ISK has weakened considerably in 2020 to date, despite a minor uptick in June. It has now fallen by over 15% against the US dollar and nearly 16% against the euro since the turn of the year. Our measurements suggest that seasonal sales are the main catalyst of the MoM drop in the CPI. We project that inflation will remain below the CBI’s target, averaging 2.4% this year, 2.2% in 2021, and 2.4% in 2022.

Summer sales and deflation

In many stores, summer sales are in full swing by now, pushing the CPI downwards. According to our forecast, the clothing and footwear component will be the main downward-pushing item this month, falling by nearly 10% MoM and lowering the CPI by 0.35%. Even so, this is a smaller decline than in July of previous years, as it is offset by the ISK depreciation. Furniture and housewares prices also fall slightly between months, by 2.15% (-0.12%). Not all summer sales have begun, however, and modest declines in the price of electronic equipment and appliances can be expected later in the season.

Opening up borders pulls in the opposite direction

According to our forecast, the travel and transport component will rise by 1.25% (0.19% CPI effect), after having fallen (on average) thus far in 2020. It is unclear how this component will develop in coming months, however, as limited supply and reduced competition on many flight routes will be offset by reduced desire and ability to travel. Petrol and oil prices have begun to rise again, after falling by an average of 2.37% over the past three months. Airlines have started offering significantly expanded flight schedules after a quasi-hibernation of about two months, and demand for fuel has risen accordingly. We expect petrol prices to rise marginally in coming months.

World Class fitness centres raised their price list by 15% between CPI measurements. A large share of Icelanders are World Class customers, and the company’s price hikes and other factors contributed to a 0.03% rise in the CPI.

Inflation moderate in the coming term

The outlook is for moderate inflation over the medium term. If our forecast materialises, inflation will hover just above the target, measuring 2.7% in August and September. We expect it to remain close to the CBI’s target this year and then dip below it in both 2021 and 2022.

Obviously, the situation is extraordinarily uncertain at the moment because of the COVID-19 pandemic, and the ISK exchange rate is the chief uncertainty in our forecast. As a result of this, we have based our forecast on the assumption that the ISK will remain broadly stable at close to the current level. If the ISK weakens further, it will give rise to further inflationary pressures in the future.

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This report is compiled by Islandsbanki Research of  Islandsbanki hf.

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