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Our forecast: CPI to rise 0.4% in March

The outlook is for a slight uptick in inflation in March, with rising petrol prices and end-of-sale effects driving most of the increase in the CPI during the month. The outlook further ahead is favourable, however, and inflation will probably fall back to the Central Bank’s (CBI) 2.5% target by the year-end.

We project that the consumer price index (CPI) will rise by 0.4% month-on-month in March, bumping headline inflation up from 4.1% to 4.2%. It appears, though, that this is the peak of the current episode and that inflation will fall rather swiftly later this year.

Petrol prices are the strongest upward-pushing item in March. Global prices have soared in recent months, owing in part to expectations of a surge in demand following the Corona Crisis, but also to measures taken by OPEC to control supply. For example, Brent crude is now selling at just under USD 70 per barrel, about 60% higher than in Q3/2020. Domestic petrol prices have already risen by about 6.5% since last October, and our survey indicates that they will rise by nearly 4% month-on-month in March (0.13% CPI effect).

On the whole, though, the end of winter sales has a slightly stronger impact on the March CPI than petrol prices do, as it involves cumulative effects on several items. For instance, we expect clothing and footwear prices to rise 3.9% (0.10% CPI effect) and furniture and housewares prices to rise by 0.9% (0.05%). This year’s winter sales were shallower than usual for Icelandic retailers. In our opinion, the March measurement will determine whether retailers simply responded to brisk demand and weaker competition from consumers’ overseas shopping by holding less aggressive sales, or whether these are inflationary effects that push prices of clothing, equipment, and housewares up higher than they were before the sales.

Apart from end-of-sale effects and petrol prices, this month’s changes in the CPI will not feature much in the way of big news. That said, we do expect motor vehicle prices and international airfares to push the index upwards by a combined 0.06%. In addition, the home maintenance item will push the CPI upwards by 0.02% and imputed rent by another 0.01%. Actually, we measured a 0.4% rise in house prices in our survey, but it appears that the downward-pushing impact of the interest rate component, a result of more favourable mortgage lending rates in the recent past, will offset that increase in the calculation of imputed rent. There is no indication that any subcomponents will have a strong upward impact this month.

Inflation likely to taper off quickly in 2021

The medium-term inflation outlook is broadly unchanged since our last forecast. Petrol prices will be something of an irritant in the next few months, but other underlying assumptions are more or less unchanged. We expect the CPI to rise by 0.2% in April, 0.2% in May, and 0.3% in June, bringing headline inflation down below the 4% upper deviation threshold of the CBI’s inflation target by May and down to 3.5% by mid-year. Thereafter, we expect twelve-month inflation to taper off quite quickly over the remainder of the year and align with the CBI’s 2.5% target by the year-end. For the two years to follow, the outlook is for target-level inflation.

According to our forecast, the main driver of disinflation in the quarters to come is the appreciation of the ISK. The ISK has held its ground in recent months, and it is more likely to strengthen than to weaken later this year, when tourism-generated revenues will hopefully start to flow into the country again. Further appreciation is likely in the next few years, driven by a growing current account surplus and sunnier times for the economy more generally. Our forecast is based on the assumption that the trade-weighted exchange rate index will average around 197 this year, 188 in 2022, and 185 in 2023. If this materialises, the ISK will be an average of 8-9% stronger in 2023 than it was in 2020. It goes without saying that developments in the ISK are highly uncertain, although in our assessment, there is much more scope for appreciation than depreciation during the forecast horizon.

Pulling in the other direction are the prospect of relatively rapid wage hikes in the coming term and a more buoyant housing market than was generally expected during the early days of the Corona Crisis. Domestic cost pressures will therefore be relatively strong in the coming term.


Jón Bjarki Bentsson

Chief economist