We project that the consumer price index (CPI) will rise by 0.9% month-on-month in February and that twelve-month inflation will measure 5.9%, up from 5.7% in January. This would be Iceland’s highest inflation measurement since April 2012. The inflation outlook has deteriorated noticeably since our last forecast. We expect inflation to reach local highs in coming months before beginning a steady decline and then aligning with the target at the beginning of 2024. It goes virtually without saying, though, that the situation is highly uncertain and that circumstances can change quickly, as we have seen in the recent term.
Our forecast: inflation to measure 5.9% in February
The outlook is for the CPI to rise by 0.9% month-on-month in February, bumping twelve-month inflation up to 5.9%, if our forecast materialises. The inflation outlook has deteriorated since our last forecast. Inflation is a global phenomenon these days, and there is a strong likelihood that imported inflation will be high in coming quarters.
Housing component weighs heavily
As in recent months, house prices are the main driver of the rise in the CPI in February. The housing component as a whole is set to rise by 0.7% (0.22% CPI effect), owing largely to an increase in imputed rent, which for the most part is a reflection of house prices. We project that imputed rent will rise by 1.1% MoM (0.19% CPI effect). Demand pressures in the housing market are very strong at present but are likely to subside in response to policy rate hikes and other Central Bank measures, such as the cap on the debt service-to-income ratio, which took effect on 1 December 2021.
End-of-sale effects and imported inflation
In our February measurements, nearly all CPI components rise between months. The end of seasonal sales affects February measurements, as is customary at this time of year, and imported inflation looks set to make its presence felt as well. According to our measurements, the furniture and housewares component will weigh heavily, with an increase of 3.1% (0.20% CPI effect), and the clothing and footwear component will rise by 4.1% (0.15%). Both of these components typically rise after the end of January sales.
Imported inflation was prominent in the January CPI measurement, and we expect it to remain so in the months to come. Our measurements indicate that petrol prices will rise by 3.4% MoM (0.11% CPI effect), and that food and beverage prices will rise by 0.7% (0.11%).
Outlook turns bleaker
Iceland is not alone in facing high and rapidly rising inflation at present. In the US, for instance, headline inflation measures 7.5%, and in the eurozone it is over 5%. Inflation is therefore a global problem these days, and optimism about a rapid decline in coming quarters has grown considerably more muted recently. This implies the risk that imported inflationary pressures will be more persistent in Iceland. The inflation outlook for the coming term has deteriorated as a result, and the situation is only compounded by the tenacious price pressures in the housing market.
According to our preliminary forecast, the CPI will rise by 0.5% in March, 0.4% in April, and another 0.4% in May. If these projections materialise, inflation will measure 5.6% in April. We expect it to remain above 5% in the quarters to come and then begin falling in earnest at the end of the year. According to our long-term forecast, inflation will average 5.5% in 2022, 3.4% in 2023, and 2.6% in 2024, and will more or less align with the Central Bank’s inflation target in the beginning of 2024.
Our forecast is based on the assumption that the housing market will settle down during the year as interest rates rise and supply firms up, and that the wage agreements up for negotiation towards the year-end will result in modest pay hikes.
There is considerable uncertainty, however, about when the pandemic-induced supply-chain bottlenecks will be dislodged. The ISK has appreciated by 4% year-to-date, which will help to dampen imported inflation in the months to come, but if supply-chain problems prove difficult to unwind, inflation could turn out more stubborn than we have forecast here.
Author
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