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29 April 2019

Inflation rises in April, but inflation outlook improves

Rising inflation in April was due mainly to a surge in airfares. The outlook is for inflation to continue at the current pace in coming months, but the outlook further ahead has brightened with the approval of wage agreements in April. The contribution of house prices to inflation has tapered off steadily in the recent past, and imported inflation looks set to subside as well. Imported price pressures, house prices, and other domestic factors each explain about a third of the current inflation rate.

According to figures released recently by Statistics Iceland (SI), the consumer price index (CPI) rose 0.37% month-on-month in April, raising twelve-month inflation to 3.3% from the March measurement of 2.9%. The CPI excluding housing rose by 0.48% during the month, however, and twelve-month inflation thus measured was 2.8%.

The April measurement is in line with published forecasts. We had projected a rise of 0.4% between months, whereas forecasts as a whole lay in the 0.3%-0.4% range. Most subcomponents also developed broadly in line with our forecast, and there were few surprises this month.

April rise due to travel and transport

International airfares rose by over 20% in April (0.29% CPI effect), explaining the lion’s share of the rise in the CPI during the month. There are two main reasons for this.

· First of all, SI’s press release mentions that WOW Air’s collapse affected calculations of the air travel/transport component. SI measures this item by surveying airfares as they were two weeks, one month, and two months earlier. In other words, the April value of the subcomponent represents the average of measurements carried out in February, March, and April. Therefore, SI had already conducted two of the measurements used in the April calculation by the time WOW failed, and presumably the calculation had to be revised because the flights included in those measurements never materialised.
· Second, Easter came relatively late this year and therefore strongly affected April air travel measurements. That impact could recede to some extent in May.

House prices flat in April

As we had expected, imputed rent fell, lowering the CPI by 0.01%. The market price of residential property virtually stood still, according to SI’s measurement; therefore, the interest subcomponent of this item had the above-mentioned downward impact, as it takes mortgage interest into account.

Two major house price categories — capital area prices and regional Iceland prices — diverged markedly in April. Detached housing in the greater Reykjavík area rose by 0.8% MoM and condominium prices by about 0.9%. In regional Iceland, however, prices declined by 2.5%, on the heels of an unusually large increase in March.

In the past twelve months, house prices nationwide have risen by 4.6%, according to SI, and real prices (deflated with the CPI) by 1.3%. Price hikes have been concentrated in regional Iceland, where the increase measures nearly 9%, while capital area condominium prices have risen 3.4% and detached housing by 4.3%.

On the whole, the housing component contributed 0.01% to the April rise in the CPI, owing to a 0.3% increase in paid rent.

Pass-through from ISK depreciation tapering off

Apart from the travel/transport component, the 0.9% rise in clothing and footwear prices contributed most to the CPI rise in April (0.04% CPI effect). In 2019 to date, however, clothing and footwear have fallen slightly in price, and there are no signs that new items appearing after the end of seasonal sales have been priced higher than older items, even though the ISK depreciated by 9.5% in the last four months of 2018.

Imported goods as a whole rose in price by 0.44% in April, the smallest MoM increase (excluding seasonal sales) since mid-2018. Imported goods prices have risen by just under 3% since the middle of 2018. This modest increase — a pleasant surprise, given the above-mentioned depreciation — is probably due in large part to stiffening competition in the retail market and growing uncertainty about consumer demand in coming months.

At present, imported inflation accounts for just over 1% of the current inflation level of 3.3%. The housing component accounts for another 1%, and domestic goods and services explain 0.5% and 0.6%, respectively. Thus it can be said, with some simplification, that imported inflation, housing, and domestic goods and services each account for about a third of inflation at present.

Inflation outlook improving

Although inflation rose somewhat in April, we think the outlook for coming quarters is improving. We expect the CPI to rise by 0.2% in May and 0.4% in June, and to remain virtually unchanged in July, leaving headline inflation at 3.3% in July.

Airfares can be expected to rise strongly as summer takes hold, owing to rising fuel prices, peak season demand, and reduced competition after the fall of WOW. Imported inflation stemming from rising goods prices should continue to taper off as the summer approaches, assuming that the ISK holds its ground. We also expect house prices to rise at roughly the current pace in coming months.

Inflation could start to ease in the latter half of the year, however. The newly landed wage agreements appear likely to cause less short-term inflationary pressure than we had feared. Furthermore, the ISK is reasonably likely to hold broadly stable despite the prospect of weaker export revenues. And finally, house price inflation will probably ease over time, and reduced demand pressures should result in smaller domestic price hikes overall. Rising wage costs will probably cause some inflationary pressures in the foreseeable future, though — pressures that could escalate further ahead.