We forecast a 0.4% drop in the CPI in January

nullWe project that the consumer price index (CPI) will fall by 0.4% month-on-month in January. If this forecast materialises, inflation will decline from 4.2% to 3.5%, as the CPI rose 0.3% in January 2013. The inflation outlook for upcoming quarters has improved considerably, in our opinion, as recent developments in the major factors jeopardising the outlook – including collective bargaining agreements, the ISK exchange rate, and fiscal consolidation – have tended to reduce inflation expectations. Statistics Iceland (SI) will publish the CPI for January at 9:00 hrs. on 30 January.

ISK appreciation strongly affects the January CPI

As usual in January, sales effects and the price of public and private services weigh in against one another in our forecast. We expect sales effects to have the upper hand, however, as there is considerable pressure on public and private entities alike to keep price increases in check. As a result, price list increases will probably be appreciably more moderate than in recent years. We expect sales on clothing and footwear to reduce the CPI by 0.6%, and we estimate the total sales effect at 0.7%.

nullDevelopments in the ISK exchange rate affect the January CPI measurement significantly. For instance, petrol prices have fallen by over 2% (-0.12% CPI effect), in spite of the fuel tax hike at the beginning of the year. Furthermore, retailers have responded to exchange rate developments and exhortations from the labour market and have cut prices on various imports in recent weeks. In addition to these factors, the seasonal decline in international airfares reduces the CPI by 0.1% in our forecast, and the reduction in VAT on disposable diapers has had a tangible effect as well. And finally, the reduction in dental care costs due to increased government subsidy of children’s dental care offsets the price increases at health care centres.

The main source of upward pressure on the CPI, apart from services prices, is the housing component (0.28% CPI effect). Our survey indicates that imputed rent will rise by 0.8% in January (0.11% CPI effect). Furthermore, utilities prices rose as usual at the end of the year, and we expect paid rent to keep increasing. Food and beverage prices have risen as well, by 0.5% (0.07% CPI effect), in spite of the above-cited downward effects, largely due to seasonal changes in fruit and vegetable prices.

Improved inflation outlook

nullA stronger króna and relatively modest pay increases in the newly finalised wage agreements will have a positive effect on near-term developments in the CPI, according to our forecast. Presumably, once winter sales are over, retailers will buy new stocks of goods at a more favourable exchange rate than they previously bought at, which should dampen end-of-sale effects. Moreover, over the next few months, the ISK appreciation since early November should seep gradually into the price of goods with a slower rate of turnover.

We expect the CPI to rise by 0.8% in February, 0.4% in March, and 0.3% in April. This would bring inflation down to 2.6% in February, whereupon it will begin to rise again. According to our forecast, it will measure 2.9% in April, 3.0% in June, and 3.1% at the end of the year. This outlook, which is considerably brighter than we had previously projected for 2014, brings the Central Bank’s inflation target within reach and keeps it there all year. We expect inflation to begin rising thereafter, however, and to measure 3.3% in 2015. Pay rises are likely to gain pace as spare capacity disappears from the economy, house prices will probably continue rising, and the ISK is quite likely to sink a bit, all of which will add to inflationary pressures.

January inflation forecast