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Surprise uptick in inflation

The CPI rose by 0.7% month-on-month in October, blowing past official forecasts. The rise in the index, driven mainly by an increase in the price of mutton, bumped headline inflation up to 9.4%. We are relatively optimistic that inflation will taper off in the coming term despite this temporary hiccup.

According to new figures from Statistics Iceland (SI), the consumer price index (CPI) rose 0.7% month-on-month in October, nudging headline inflation up to 9.4% from the September measurement of 9.3%. Twelve-month inflation fell in August and September but inched upwards this month. Twelve-month inflation according to the CPI excluding housing measured 7.2%, however.

The September measurement was above all official forecasts, including our own updated forecast, which assumed that the CPI would rise by 0.3%. The main difference between our forecast and SI’s measurements lies in the price of food, which rose far more than we had expected, as did imputed rent.

Mutton the main driver of the jump in the CPI

The surprise increase in the CPI was due to a spike in food and beverage prices. The component as a whole increased by 1.6% (0.23% CPI effect), in which a 16% surge in the price of mutton (0.09% CPI effect) weighed heaviest. On the basis of news coverage warning of a spike in product prices, we at ÍSB Research had forecast that mutton prices would rise in coming months, but it took us aback that the hike should take place in a single month.

A number of other items also rose in price in October, including furniture and housewares, up 1.4% (0.09% CPI effect), and clothing and footwear, up 1.2% (0.04%). Both of these items have a tendency to rise after the end of summer sales, sometimes as late as October. Furthermore, petrol prices rose 1.3% (0.05%) and recreation and culture prices by 0.6% (0.05%).

But there were several items that pushed this month’s CPI measurement downwards, chiefly to include hotel and restaurant services, which fell by 0.6% (-0.03%), and other goods and services, which fell 0.3% (-0.02%). Hotels and guesthouses tend to lower their prices in October, once the peak tourist season is over.

House prices fluctuate month-on-month

It came as no surprise that imputed rent should rise MoM in October, after the rise in the capital area house price index, published last week. Imputed rent rose by 0.8% (0.16% CPI effect), driven by the interest component and housing market prices. The market price of housing rose 0.6% MoM, as single-family home prices in the capital area increased by 1.7% and prices in regional Iceland rose 1%. On the other hand, capital area condominium prices were flat MoM. Clearly, the market is subject to fluctuations at the moment, and single-family home prices are a particular source of volatility, given the unusually small number of purchase agreements made in greater Reykjavík in the recent past, as we have reported recently.

In spite of this MoM increase, twelve-month house price inflation is still losing pace and now measures 21.6%. Interestingly, the twelve-month rise in both capital area condominium prices and housing in regional Iceland measures 21.6% as well. Detached home prices have also risen broadly at that pace in the past year, or 21.9%. These three key market segments are therefore marching in step at the moment, after having diverged widely in the relatively recent past.

Inflation set to fall in coming months

As is noted above, inflation according to the CPIXH (excluding housing) measures 7.2%. A breakdown of inflation by type and source shows that the weight of the housing component has declined over the past two months, and given the rapid cooling of the housing market, this trend can be expected to continue. Of this month’s 9.4% headline inflation figure, 3.7% stems from housing, 2.2% from imported goods, 2% from services, and 1.5% from domestic goods. It is clear, then, that inflation is ubiquitous these days and inflationary pressures relatively widespread.

The near-term outlook is for a more tranquil housing market, although prices have certainly bounced around recently and could well keep doing so. There is also the prospect of lower imported inflation in the coming term. According to our forecast, these two factors will have a dampening effect on inflation in the near future, although month-to-month volatility like that seen in October is a distinct possibility. Nevertheless, we are embarking on a period in which months with hefty rises will drop out of twelve-month measurements and will hopefully be replaced by months with more moderate ones. We forecast that the CPI will rise by 0.2% in November and 0.3% in December, and then fall by 0.3% in January. If our forecast materialises, inflation will measure 8.2% in January and average 8.2% for 2022 as a whole.

According to our long-term forecast, inflation will average 5.9% in 2023 and 3.7% in 2024. But we need hardly mention that the outlook is highly uncertain, and our forecast is based on the assumption that the housing market will be calmer and both imported and domestic inflation will lose momentum. The other major uncertainty in our forecast is the upcoming round of wage negotiations, although we have already assumed that wages will rise markedly in 2023.


Bergthora Baldursdottir