Housing market still buoyant

House price inflation still shows no sign of abating and, as in recent months, is the main driver of this month’s rise in the CPI, according to our forecast. The housing component as a whole is set to rise by 1.5% (0.45% CPI effect), owing mainly to an increase in imputed rent. We project that imputed rent, which generally reflects developments in house prices, will rise by 2.2% month-on-month (0.42% CPI effect). The home maintenance and repair subcomponent will rise by 1.8% (0.02% CPI effect), as the building cost index has risen markedly in the recent past and the price of imported inputs, for instance, has

There is no sign of an imminent slowdown in house price inflation, and we expect imputed rent to keep rising at roughly the current pace in the months to come. Hopefully house prices will settle down as the year progresses, once higher interest rates and increased supply begin to make their mark.

Most CPI components rise, but airfares fall

Most other items are likely to rise between months. Apart from the housing component, food and beverages are expected to weigh heaviest in the May increase in the CPI, rising by 0.7% (0.11% CPI effect), according to our forecast. Food prices are up 3.8% year-to-date and look set to keep climbing in coming months.

According to our forecast, petrol prices will increase by 1.6% (0.06% CPI effect). According to SI figures, they have risen by nearly 13% YTD, propelled by soaring fossil fuel prices in the global market. Other upward-pushing items for this month include recreation and culture (0.04% CPI effect), hotel and restaurant services (0.03%), and other goods and services (0.04%).

The main item pushing against rising house prices and imported inflation is the drop in airfares. Air transport prices rose nearly 22% in April, driven by higher fuel prices and a surge in demand. In part, this reflects the usual seasonal pattern, with airfares rising around Easter and easing again in the following month. Our measurements suggest that this is indeed at play, and we forecast that air transport prices will fall by 6.6% (-0.14% CPI effect) in May, the only component that we expect to decline MoM.

Inflation set to rise in coming months

Inflation is a global phenomenon at present. In the US, for instance, headline inflation measures 8.3%, and in the eurozone it is 7.4%. It is extremely uncertain how long it will take to unwind supply chain problems abroad, and until that happens, imported inflation will continue to rise in Iceland.

Because the outlook is for increased imported inflation and a continued rise in house prices over the months to come, we expect headline inflation to climb still higher. According to our forecast, no real decline in inflation is on the horizon until well into 2023. In our short-term forecast, we project that the CPI will rise by 0.7% in June, and 0.4% in July, and 0.6% in August, pushing headline inflation up to 8.4% by August.

Our long-term forecast has changed relative to its predecessor. We have updated our projections of foreign inflation and domestic wage and house price movements for the remainder of the forecast horizon. House price inflation looks set to ease later this year, as more new properties become available and mortgage lending rates rise. It is extremely important for developments in inflation – and one of the key assumptions underlying our long-term forecast – that this should materialise, as a slower rise in house prices will offset higher imported inflation.

Another important assumption behind our long-term forecast involves the wage agreements up for negotiation late this year. We expect wage hikes to be sizeable but not off the charts. According to our forecast, inflation will average 7.6% in 2022, 5.9% in 2023, and 3.9% in 2024.

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