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.

LEGAL DISCLAIMER

This report is compiled by Islandsbanki Research of  Islandsbanki hf.

The information in this report originates in domestic and international information and news networks that are deemed reliable, along with public information, and Islandsbanki Research’s own processing and estimates at each time. The information has not been independently verified by Islandsbanki which therefore does not guarantee that the information is comprehensive and accurate. The views of the authors can change without notice and Islandsbanki holds no obligation to update, modify or amend this publication if assumptions change.  

This publication is only published for informational purposes and shall therefore not be viewed as recommendation/advice to make or not make a particular investment or an offer to buy, sell or subscribe to specific financial instruments. Islandsbanki and its employees are not responsible for transactions that may be carried out based on information put forth in the report. Before making an investment decision, recipients are urged to seek expert advice and get well acquainted with the investments market and different investment alternatives. There are always financial risks related to investment activities, including risk due to international investments and fluctuations in the exchange rate of currencies. Investors’ investment objectives and financial position vary. Past performance does not indicate nor guarantee future performance of an investment. 

The research report and other information received from Islandsbanki are meant for private use only. The materials may not be copied, quote or distributed, in part or in whole, without written permission from Islandsbanki.

This report is a short compilation and should not be considered to contain all available information on the subject it discusses. 

Supervisory body: The Financial Supervisory Authority of Iceland (www.fme.is).    

UNITED STATES

This report or copies of it must not be distributed in the United States or to recipients who are citizens of the United States against restrictions stated in the United States legislation. Distributing the report in the United States might be seen as a breach of these laws.

CANADA

The information provided in this publication is not intended to be distributed or circulated in any manner in Canada and therefore should not be construed as any kind of financial recommendation or advice provided within the meaning of Canadian securities laws.

OTHER COUNTRIES

Laws and regulations of other countries may also restrict the distribution of this report. 

Further information regarding material from Islandsbanki Research can be accessed on the following website: http://www.islandsbanki.is.