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Our forecast - CPI to rise 0.7% in February

The outlook is for headline inflation to slide in February despite a 0.7% month-on-month rise in the consumer price index (CPI). The short-term inflation outlook has deteriorated slightly because of rapidly rising petrol prices. However, inflation looks set to taper off quite quickly during the year and be at the Central Bank’s (CBI) 2.5% target from end-2021 onwards.

We project that the consumer price index (CPI) will rise by 0.7% MoM in February, bringing inflation down from 4.3% to 4.1%. Inflation will therefore remain above the 4% upper tolerance limit of the CBI’s inflation target and is unlikely to fall below it again until April. The end of seasonal sales explains the lion’s share of the increase in February, although petrol prices and the housing component push upwards as well. On the other hand, the outlook is for a swift decline in inflation thereafter.

End-of-sale effects, housing, and petrol push the CPI upwards

As is typically the case at this time of year, the end of winter sales affected the February CPI measurement. Sales on clothing were unusually thin in January, however, and we expect the inflationary end-of-sale effect in February to be correspondingly mild. We expect the clothing and footwear component of the CPI to raise the index by 0.12% this month, well below the February average of 0.16% in recent years. We also expect the furniture and housewares component to push the index upwards by 0.2% and the recreation and culture component to add another 0.07%. All in all, we expect end-of-sale effects to explain roughly 2/3 of the month’s rise in the CPI.

The housing market is lively at present, and our survey suggests that house prices will be 0.8% higher in Statistics Iceland’s (SI) February measurement than in January. On the other hand, falling mortgage lending rates pull in the opposite direction, and we project that the imputed rent component, which is more or less a composite of house prices and lending rates, will rise by 0.4% this month. Added to this is a sizeable increase in the home maintenance subcomponent. SI’s building cost index for February shows an increase of just over 6% in the labour component, which indicates that the labour component of the maintenance measurement will rise commensurably.

Petrol prices have risen markedly in Iceland in recent weeks. This reflects a steep rise in global oil prices, with Brent crude prices up more than 50% since early November. in large part, the increase is attributable to expectations of a surge in demand for fossil fuels and other petroleum products once the Corona Crisis subsides around the world. In the past few days, however, OPEC’s plans to cut production have also made an impact. A barrel of Brent crude currently costs just over USD 60, the highest price seen in more than a year. According to our survey, petrol prices in Iceland rose by 2.3% in February, pushing the CPI upwards by 0.07%.

Target-level inflation expected from end-2021 onwards

In our view, the short-term inflation outlook has deteriorated slightly since our last forecast. This is due mainly to the aforementioned jump in petrol prices, coupled with higher January inflation than we had anticipated. We expect inflation to subside steadily over the course of 2021, however, as the effects of last year’s ISK depreciation and the end-2020 wage hikes taper off, the slack in the economy comes more fully to the fore, and the months featuring large increases drop out of twelve-month measurements.

We forecast that the CPI will rise by 0.3% in March, 0.2% in April, and 0.3% in May. If these projections materialise, inflation will measure 3.6% in May. We then expect it to ease further as the year advances. We forecast that it will align with the CBI’s 2.5% target around the year-end and then remain there for the two years to follow.

As always, the ISK exchange rate will be a key determinant of developments in inflation. Our forecast is based on the assumption that the ISK will be an average of 6-7% stronger in 2023 than it was in 2019 (again, on average). The resurrection of the tourism industry will strongly affect how the forecast plays out, but barring a severe setback in the pandemic and the rebound in global tourism, both the current account balance and foreign currency flows should improve in coming months.

The outlook is for house prices to rise steadily in the coming term, as demand is strong and the supply of new flats is starting to decline. Furthermore, we expect wages to rise in line with Living Standards Agreements and other similar agreements made recently, although we do not expect much wage drift.


Jón Bjarki Bentsson

Chief economist