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Our forecast: inflation to remain flat month-on-month

Inflation will be unchanged between months if our forecast materialises. The depreciation of the ISK and continued house price increases are the main reason inflation will subside more slowly than previously forecast.

We project that the consumer price index (CPI) will rise by 0.3% month-on-month in November and that twelve-month inflation will be unchanged at 9.4%. Rising imported goods prices (food prices in particular) and continuing house price inflation are the main drivers of the rise in the CPI in November.

Our inflation forecast for this month is somewhat bleaker than our October forecast. Our increased pessimism stems mainly from the ISK, which has weakened markedly, affecting the local currency price of imported goods. In addition, house price inflation has proven more intractable than we previously expected. Prices have been quite volatile recently, after the market cooled suddenly in late summer.

House prices turn volatile

The housing market has taken us a bit by surprise in recent months. It cooled abruptly in late summer, in the wake of policy rate hikes, and looked as though it was finally going to settle down – and without delay. But as US baseball great Yogi Berra said, “It ain’t over ‘til it’s over,” and sure enough, prices jumped again in the autumn. The house price index, published earlier this week, rose by 0.6% month-on-month in October, driven by higher condominium prices, whereas the 0.8% increase in September was due to a rise in single-family home prices. The market is therefore swinging this way and that for the present and will probably keep doing so for the next few months before some sort of equilibrium is restored.

Statistics Iceland (SI) measures housing market prices in a manner similar to that used to compile Registers Iceland’s (RI) house price index. Both indices are based on three-month moving averages according to registered purchase contracts, but the main difference between them is that SI’s index also captures regional Iceland, while the RI index covers only the capital area. There is a fairly strong correlation between the two, as the chart above indicates. The chart shows the market price of housing with a one-month lag, based on the RI house price index. Last month’s house price index value can therefore give a reasonably accurate indication of house prices in SI’s November measurement.

We forecast that imputed rent, which is based on housing market prices and mortgage interest, will rise by 0.7% MoM (0.14% CPI effect). We then expect prices to ease steadily over the next several months. Paid rent is projected to rise by 0.6% (0.03% CPI effect), and the housing component as a whole will therefore increase by 0.6% (0.17% CPI effect), if our forecast is borne out.

ISK falls; imported goods prices rise

The outlook is for higher imported goods prices over the months to come, owing to the recent depreciation of the ISK. Since the beginning of summer, the exchange rate has fallen by nearly 8% against major currencies, and since the last inflation measurement it has fallen by almost 5%. This has a tangible effect on import prices. Last month, food and beverage prices rose by 1.5%, owing primarily to a 16% jump in the price of mutton. Such outliers are difficult to predict, and this one strongly affected the October measurement.

Based on measurements taken in November, the weaker ISK is making its mark on various goods prices. The main upward-pushing CPI components are food and beverages, which are set to rise by 0.5% and increase the index by 0.08%, and furniture and housewares, which will rise by 0.9% and push the index up by 0.06%.

Other inflationary items are petrol, up 0.9% (0.03% CPI effect); other goods and services, up 0.4% (0.03%); and health, up 0.6% (0.02%), reflecting the fact that pharmaceuticals prices generally move with the ISK exchange rate.

What will pull in the opposite direction is the decline in airfares. Airfares typically fall in November, and our measurement suggests that this year will be no exception. We expect air transport prices to fall by 7.2% (-0.18% CPI effect).

Inflation set to subside more slowly than we had anticipated

Our November inflation forecast is rather more downbeat than its predecessor. Inflation will probably fall more slowly than we previously expected, and this time the key culprits are the ISK and the housing market. We can console ourselves with base effects, however, as months with hefty price increases are set to drop out of twelve-month measurements soon. As a result, inflation is highly likely to fall in the near future, even if it does so more slowly than previously forecast. According to our preliminary forecast, the CPI will rise by 0.4% in December, fall by 0.2% in January, and then rise by 0.6% in February. If this forecast is borne out, twelve-month inflation will measure 7.9% in February.

The CBI’s 2.5% inflation target is still quite a way off, and our forecast suggests that inflation will not return to target during the forecast horizon. If the ISK stabilises and the housing market calms down, it will do much to lower inflation in the near future. According to our long-term forecast, inflation will average 6.4% in 2023 and 4% in 2024.

A number of factors must line up if inflation is to fall quickly. The key assumptions underlying our forecast are a cooler housing market and a stronger ISK later in the forecast horizon. Another uncertainty – and an important one – is the upcoming wage agreements, as the labour market is very tight at present and it is clear that negotiations will be extremely challenging in the months to come. Nevertheless, we have already incorporated sizeable pay rises in 2023 into our forecast.


Bergthora Baldursdottir




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