Inflation to go below inflation target in February

nullWe project that the consumer price index (CPI) will rise by 0.8% month-on-month in February. If this forecast materialises, inflation will decline from 3.1% to 2.3%, as the CPI rose 1.6% in February 2013. According to this, inflation will fall just below the Central Bank’s (CBI) inflation target during the month and reach its lowest point since March 2011.

The inflation outlook for the current year is relatively bright, although we expect 2014 to see inflation rise again in tandem with increased economic activity. If the forecast materialises, however, year-2015 inflation will still be well below the average since the adoption of the inflation target. Statistics Iceland (SI) is scheduled to publish the February CPI at 9:00 hrs. on 27 February.

End-of-sale effects and airfares the strongest inflationary factors

 nullEnd-of-sale effects will push the CPI sharply upwards, as they usually do in February. We expect the clothing component of the index to raise it by 0.27% during the month, and combined with other components, end-of-sale effects overall will increase the index by approximately 0.4%. This year’s end-of-sale effects are relatively mild, however, owing to the recent appreciation of the ISK, which means new goods can be imported at lower prices than the previous ones.

In addition, we expect international airfares to rise substantially, on the heels of a steep decline in January (0.21% CPI effect). Furthermore, petrol prices have risen somewhat since the last measurement (0.05% CPI effect).

On the other hand, the outlook is for the housing component to have a weaker upward effect on the CPI than it has in recent months – and a weaker one than we assumed in our preliminary forecast. Information from the market suggests that, in this month’s measurement, imputed rent will rise by 0.2%, the smallest increase since last October. We forecast the housing component as a whole to rise by 0.14% (0.04% CPI effect). Because of the appreciation of the ISK, imported goods prices will rise more slowly than they would otherwise, and could even decline slightly.

Inflation moderate this year, gains pace thereafter

 According to our forecast, the appreciation of the ISK since end-November and the relatively modest wage increases negotiated with about half of the employees in the private sector will have a positive effect on the CPI in coming months. Prices of imported goods and inputs for domestic production have probably fallen somewhat, and this will pass steadily through to upcoming CPI measurements.

nullWe expect the CPI to rise by 0.3% in March, 0.3% in April, and 0.2% in May. According to this, twelve-month inflation will measure 2.7% in May. It will range between 2.5% and 3.0% for the remainder of the year and measure 2.7% at the year-end, according to our forecast.

We expect inflation to rise somewhat beginning next year, averaging 3.4% over 2015 as a whole and 3.8% in 2016. The rising inflation in our forecast goes hand-in-hand with growing economic activity, as we assume that wages and house prices will rise more rapidly as the forecast horizon progresses and that the ISK will lose a bit of ground in coming years. Nevertheless, inflation will be well below its post-inflation targeting average of 5.8% in coming years.