We forecast a 0.1% fall in the CPI in November

We project that the consumer price index (CPI) will fall 0.1% month-on-month in November, lowering twelve-month inflation from 1.9% to 1.4% and making November the tenth consecutive month with inflation below the Central Bank’s (CBI) 2.5% inflation target. If the forecast materialises, headline inflation will be at its lowest since the beginning of 2003. 

As before, the near-term inflation outlook is excellent and, in fact, has improved steadily in the recent past. We now expect inflation to remain below the Central Bank’s (CBI) 2.5% inflation target through mid-2015 and then rise thereafter as the economy gains traction, yet remain close to target. Statistics Iceland (SI) is scheduled to publish its November CPI measurement at 9:00 hrs. on 26 November. 

Travel and transport pull downwards

The main difference between the November forecast and our preliminary forecast for the month (which provided for a 0.2% increase) lies in the travel and transport component of the CPI, which now accounts for a 0.2% decline in the index. One factor at work here is the 12% drop in international airfares (-0.17% CPI effect) that we expect for this month based on our price survey. The other factor is a decline in petrol prices of just under a percentage point (-0.04% CPI effect) from the October CPI measurement. We also anticipate marginal declines in other subcomponents of travel and transport.

Housing inflation loses pace 

We expect the housing component to push the CPI upwards by 0.05% in November. There are signs of a slower rise in house prices than has been the case in recent months. We expect imputed rent to rise by 0.2% in November and paid rent to rise by 0.4%. 

The outlook is for a measurable drop in the price of fruit and vegetables in the November CPI measurement (-0.03% CPI effect). Apart from these items, we don’t expect the November CPI measurement to convey much in the way of big news, as other items combined appear likely raise the index by 0.1% during the month. 

Is the low-inflation episode a fleeting phenomenon?

We expect the CPI to rise 0.2% in December. According to this forecast, inflation will measure 1.1% at the end of the year. This would result in the slowest pace of twelve-month inflation in 15 years and the lowest measurement seen since the adoption of the inflation target in March 2001. Several factors explain the unusually limited inflationary pressures at present. First of all, import prices have fallen overall in the past year, due to the appreciation of the ISK and to declining foreign commodity and consumer goods prices. Domestic cost pressures have been under control as well, largely due to the modest contractual wage increases negotiated at the beginning of the year. 


But the outlook is for an upturn in inflation next year. The wage contracts negotiated early in 2015 will probably entail larger percentage increases than were agreed at the beginning of 2014. Tension is developing in part of the labour market, and wage drift could therefore gain momentum. There is also the prospect of a continued rise in real house prices in coming years. 

We expect inflation to measure 3.0% in 2015 and 3.1% in 2016. As before, our long-term forecast is based on several assumptions: that house prices will rise by 5-7% per year throughout the forecast horizon, that wage hikes will accelerate markedly in the near future as tension grows in the labour market, and that the ISK exchange rate will remain broadly unchanged. It should be noted, however, that the uncertainty in the forecast is concentrated on the upside. Wage increases could easily exceed expectations, and the ISK is likelier to weaken rather than strengthen as time passes, although the CBI appears ready to take action to promote exchange rate stability in the near term. 

ISB Research inflation forecast