The markets are still highly uncertain, and the ISK has depreciated by about 14% year-to-date against major currencies, owing to the COVID-19 pandemic. According to our measurements, imported goods prices will rise somewhat this month, driven by the ISK depreciation, whereas other factors will pull in the opposite direction. This seesaw effect is the reason we expect modest inflation in the coming term. We project that inflation will remain below the Central Bank target this year, averaging about 2.2%, and then average 2.4% in both 2021 and 2022.

ISK depreciation pushes imported goods prices upwards

Our measurements show clearly that pass-through effects from the ISK depreciation have pushed various goods prices upwards this month. Among the items affected are furniture and housewares, which have risen in price by 1.5% (0.08% CPI effect) instead of falling, as is their usual pattern in May. In addition, our measurements indicate that food and beverages, which have already risen in price by 2.7% year-to-date, will increase 0.5% month-on-month (0.06% CPI effect).

Higher prices for drugs and medical products will also push the index upwards. This segment of the health component rose by 2.3% in April, and we expect another 2.3% increase this month (0.04% CPI effect). The increase is presumably driven by the usual suspects: exchange rate pass-through from the depreciation of the ISK, coupled with a pandemic-fuelled boom in global demand for drugs and medical goods and rising transport costs.

Is COVID-19 starting to affect the housing market?

According to our measurements, the housing component will increase by 0.3% (0.10%) this month. The main upward-pushing item is repair and maintenance, which we expect to rise by 2.4% (0.12%), mainly because of an increase in the labour component in the building cost index, stemming from an increase in living standards agreements during the month. Imputed rent, which for the most part reflects developments in house prices, is set to fall by 0.20% (-0.03% CPI effect), according to our measurements. This component has already fallen by nearly 2% in the past three months.

Statistics Iceland’s measurements for this month are based on purchase agreements finalised in February, March, and April, and our own measurements indicate clearly that the COVID-19 pandemic has begun to show in the data. In our recent macroeconomic forecast, we projected that real house prices will fall in the next two years – by over 3% this year and by 2.4% in 2021 – due to the impact of COVID-19 on the economic outlook.

Petrol prices continue to fall

According to our forecast, the travel and transport component will fall by 0.6% MoM (-0.09% CPI effect). The main contributor here is fuel prices, which we expect to fall by 3.4% (-0.11% CPI effect). Crude oil prices have plummeted recently, although in Iceland the impact is muted somewhat by the ISK depreciation. In the past three months, the component has already fallen by over 9%.

We expect a 3.6% drop in airfares (0.06% CPI effect), although the sparsity of flight offerings makes forecasting difficult at the moment. The situation could change in the next few months, however, as the border is set to open in June, and it will probably become easier to measure developments.

Inflation moderate in the coming term

The inflation outlook for the next few months is reasonably favourable. We expect the CPI to rise by 0.3% in June, then fall by 0.2% in July, and rise again by 0.2% in August. If our forecast materialises, inflation will remain below the target, measuring 2.1% in August.

We expect inflation to remain moderate throughout the forecast horizon and to be close to the CBI’s inflation target in both 2021 and 2022, owing mainly to the tug-of-war between the depreciation of the ISK, on the one hand, and a negligible rise in house prices and smaller wage cost increases, on the other.

Obviously, uncertainty is unusually pronounced at present, and the ISK is among the main uncertainties in our forecast. Our forecast is based on the assumption that the exchange rate will hold relatively steady near the current level, but if it falls more than we anticipate, imported goods prices will rise more than we have projected here.

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.