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Our forecast: inflation to measure 4.4% in May

The outlook is for the CPI to rise by 0.4% month-on-month in May; however, twelve-month inflation will ease to 4.4% during the month if our forecast materialises. House prices are the main driver of inflation this month, owing to the bustling housing market. Inflation has been more persistent in the recent past than we have forecast, but the outlook is quite good.

We project that the consumer price index (CPI) will rise by 0.4% MoM in May and that twelve-month inflation will measure 4.4%, down from 4.6% in April. Inflation appears to have peaked in April is set to start falling, albeit more slowly than we had previously expected. We expect it to align with the Central Bank’s (CBI) 2.5% inflation target around mid-2022. Statistics Iceland (SI) is scheduled to publish the CPI for the month on 27 May.

House prices the main upward-pushing item

The housing market is buoyant at present, and rising house prices have made their mark on the CPI in recent months. Imputed rent rose by 2.5% MoM in April and is up by a total of 3.8% year-to-date. Imputed rent is derived from housing market prices and mortgage interest, two variables that have been pulling in opposite directions recently. In 2021 to date, house prices have risen by 5.3% and the interest component has lowered imputed rent by 1.5%.

We project that property prices will keep rising and will weigh heavily in the May CPI measurement. According to our measurements, imputed rent will rise by 1.40% in May (0.23% CPI effect). Demand is brisk in the housing market at present, mainly because of rising real wages, households’ strong financial position, and favourable borrowing terms. On the supply side, there seems to be a significant shortage of flats – a situation that is unlikely to be rectified in the next few quarters.

Other upward-pushing components

Other items we expect to affect the CPI measurement in May are recreation and culture (0.04% CPI effect), food and beverages (0.03%), and travel and transport (0.03%). In other respects, changes in the CPI should be relatively minor this month. Ever since the pandemic struck, it has been difficult to forecast developments in travel and transport by air, which is a subcomponent of the transport component of the CPI. We expect passenger transport by air – i.e., airfares – to rise by 1.8% MoM (0.03% CPI effect). We hope it will be easier to interpret this item and that the air travel market will begin to revive with the relaxation of border restrictions and the rising share of vaccinated Icelanders.

Composition of inflation

It is worth noting that the housing market is not the only source of inflationary pressures at the moment. In April, when headline inflation measured 4.6%, the main driver was imported goods, which accounted for 2%, followed by the housing component (0.9%), domestic goods (0.8%), and services (0.8%). In essence, then, the housing market accounts for about 20% of inflation.

Inflation more stubborn than expected, but the outlook is favourable

Inflation has been more persistent than we have projected in the recent term. But we think it has peaked and will start to taper off in the near future, albeit at a more sluggish pace than we had previously forecast. We forecast a 0.4% rise in the CPI in June, no change in July, and a 0.4% increase in August, leaving headline inflation at 4.2% in August. We expect it to decline more quickly thereafter and to reach the CBI’s target around mid-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 – which we do expect later this year, once tourists begin to visit Iceland again.

On the other hand, the housing market is vibrant at the moment, and if house prices spiral out of control, as they did in 2017, inflation could become more firmly entrenched than we assume. Furthermore, the outlook is for sizeable pay rises in the coming term, which could also affect the CPI. It is also worth noting that price movements abroad and rising shipping costs due to the pandemic could affect domestic prices more than we currently anticipate. Commodity prices have been rising, and if they continue, it is quite possible that imported goods prices will climb higher and inflation will be more stubborn in coming quarters than we have provided for in this forecast.


Bergthora Baldursdottir