Our forecast: inflation to measure 4.2% in July

The outlook is for a 0.1% month-on-month rise in the CPI, lowering headline inflation to 4.2% in July if our forecast materialises. Summer sales will offset higher fuel prices and airfares. Inflation will begin easing slowly and steadily in the near future, and we forecast that it will align with the Central Bank’s (CBI) target in Q3/2022.


We project that the consumer price index (CPI) will rise by 0.1% MoM in July and that twelve-month inflation will measure 4.2%, down from 4.3% in June. We expect it to fall gradually over the course of the year and align with the CBI’s 2.5% target in Q3/2022. Statistics Iceland (SI) will publish the July CPI on 23 July.

House price inflation losing momentum?

Rising house prices have affected the CPI in recent months. The imputed rent component of the index has risen by over 6% year-to-date, as market prices are up nearly 8% while interest rates are down by just under 2%. These two variables have been engaged in a tug-of-war recently.

Last month, housing market prices rose by 0.85%, the weakest MoM increase since February. We expect that this trend will continue and house prices will keep rising in coming months, but at a slower pace than in the recent past. According to our measurement, imputed rent will rise 0.4% MoM in July (0.07% CPI effect), far less than in recent months.

Summer sales to offset higher fuel prices and airfares

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 7.2% MoM and lowering the CPI by 0.25%. Furniture and housewares prices will also be affected by summer sales, falling 2.2% in July (-0.12% CPI effect).

The strongest upward-pushing item in July is the travel and transport component, which looks set to rise by 1.6% (0.25%), according to our measurement, driven mainly by fuels and air transport prices. According to our survey, fuel prices will rise 3.7% MoM (0.12% CPI effect). Global oil prices have risen steadily in the recent term, with Brent crude now selling at just over USD 72 per barrel. In addition, airfares will rise 6.5% MoM (0.10% CPI effect). International airfares have risen nearly 8% in the past two months, as the airline market shows signs of coming back to life. Demand can be expected to grow in coming months, due to travel-hungry Icelanders and increased tourist numbers. As a result, we anticipate a further rise in airfares over the next few months.

Other items pushing the CPI upwards in July are recreation and culture (0.04% CPI effect) and hotels and restaurants (0.05%).

Inflation to taper off

According to our forecast, inflation will ease to 4.2% in July. We forecast a 0.5% rise in the CPI in both August and September, followed by a 0.2% increase in October. If these projections materialise, inflation will measure 4.1% in October. Thereafter, we expect it to fall at a quicker pace, reaching the CBI’s 2.5% target in Q3/2022. 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 have mentioned repeatedly, we expect the ISK to gain strength as tourist numbers pick up. That said, excessive house price and wage inflation could cause headline inflation to be higher and more persistent.

We are also quite concerned about imported inflation. Commodity prices have been on the rise and have already made an impact in Iceland, including on petrol prices. If this trend continues, domestic prices will follow suit, and inflation will be more persistent than we assume here.

Höfundur


Bergthora Baldursdottir


Economist

Contact

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