Morgunkorn Íslandsbanka

Inflation remains below target


Inflation is still somewhat below the Central Bank’s (CBI) inflation target after a 0.3% rise in the consumer price index (CPI) in May. Developments during the month were broadly in line with expectations. It can be assumed that inflation will remain below the 2.5% inflation target until the autumn and then begin to rise. 

According to figures released recently by Statistics Iceland (SI), the consumer price index (CPI) rose 0.28% month-on-month in May, in line with our forecast and the median forecast from market agents. We had forecast a rise of 0.3% month-on-month, whereas forecasts lay in the 0.2-0.4% range. Twelve-month inflation now measures 1.6%, up from 1.4% in April. Inflation has been below the Central Bank’s inflation target for 16 consecutive months. In terms of the CPI excluding housing, however, twelve-month inflation measures 0.3%, marking the end of what can be called a deflationary period dating from last October. 

Strikes affect the housing component

The housing component has been the cause of most of the rise in the CPI in the past twelve months. In May, however, it rose by only 0.15% (0.04% CPI effect), the smallest increase since last November. Presumably, this is due in large part to the strike among lawyers who work for capital area Commissioners’ offices, which has meant that no purchase agreements have been registered since Easter. This, in turn, means that no new house price measurements are included in the imputed rent component of the CPI, even though the oldest measurements drop off the index between months. Imputed rent rose by only 0.1% (0.01% CPI effect) in May, somewhat below our forecast. Paid rent rose by about 0.5% (0.03% CPI effect) over the same period, however. 

Sharp rise in food prices

Food and beverage prices rose by nearly a percentage point in May, explaining about half of the rise in the CPI (0.14% CPI effect). This increase, which is considerably larger than we had anticipated, is due mainly to much larger rises in meat and vegetables prices than we had expected. As regards meat, it can be assumed that the strike-induced shortage of some types of meat was the main cause of the steep price hike. However, we do not have a handy explanation for the rise year-to-date in vegetable prices, the largest January-May increase since 2010. The petrol component of the index rose 2.3% (0.08% CPI effect), in line with our forecast, due to increases in global petrol prices. 

Hotel and restaurant services prices rose by 0.9% (0.05% CPI effect), due largely to a 9.6% rise in hotel accommodation prices. This accords with our expectations, as the peak tourist season is now upon us. Furthermore, clothing and footwear prices rose by 0.8% (0.04% CPI effect), somewhat more than we had expected. 

Of the components that declined MoM, furniture and housewares prices fell 0.65% (-0.03% CPI effect), whereas we had projected only a marginal change. Air transport prices declined 4.0% (-0.06% CPI effect), primarily due to a more than 5% drop in international airfares, which is slightly more than we had projected. 

Modest inflation through the autumn

The outlook for the coming months is broadly unchanged, in our estimation. The housing component could rise somewhat more in June, however, if a wage settlement is reached with the aforementioned lawyers and house purchase agreements from April and May are included in SI’s measurement of imputed rent. Furthermore, petrol prices have already risen by nearly a percentage point since the May CPI measurement was carried out (0.03% CPI effect). These factors do not weigh heavily enough as yet to change our June forecast, and a drop in meat prices could be forthcoming if labour disputes are resolved in the next few weeks. 

According to our current preliminary forecast, we expect the CPI to rise 0.4% in June, fall by 0.2% in July, and then rise again in August, by 0.4%, bringing twelve-month inflation to 1.8% by August. After that time, we expect inflation to pick up, probably rising above the CBI’s 2.5% inflation target in the fourth quarter of this year, owing both to base effects from the unusually favourable developments in the latter half of 2014 and an accelerated MoM rise in prices. 

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