We forecast a 0.1% rise in the CPI in April

We expect the consumer price index (CPI) to rise by 0.1% month-on-month in April. If this forecast materialises, inflation will decline from 1.6% to 1.4%, thereby remaining well below the Central Bank’s (CBI) 2.5% inflation target. 

The inflation outlook has improved somewhat from our last forecast, even though we now expect house prices to rise more steeply in coming months. We expect inflation to be below the CBI’s inflation target for most of 2015 and close out the year right around the target. The outlook is for inflation to rise thereafter but remain below the 4.0% upper deviation threshold of the target. Statistics Iceland (SI) is scheduled to publish the April CPI at 9:00 hrs. on 29 April. 

April inflation measurement unsurprising?

It appears as though the CPI components that usually have the greatest effect from month to month will remain broadly stable this time. This is particularly the case with the housing component, which has been the main driver of inflation in the recent past. Our survey indicates that housing market prices will change relatively little this month – and the paid rent subcomponent of the CPI likewise. This is somewhat unexpected after the sharp rise in the recent past, but coming months will reveal whether this is merely an outlier, as monthly volatility has remainedconsiderable  (see chart), or whether housing inflation has slowed down. We expect the housing component as a whole to rise by 0.06% (0.02% CPI effect). 

The same can be said of petrol prices, which contributed strongly to the March CPI measurement. Our survey actually suggests an increase of 0.9% between months, but it is noteworthy that SI’s measurement for March showed a somewhat larger increase than our survey had indicated. Therefore, we expect SI’s measurement to show an increase of just over 0.2% this time (0.01% CPI effect). 

Another item that has often made a strong impact on monthly CPI measurements is international airfares. This month, however, our price survey indicates little change, although the airfares component is difficult to predict, and our measurements and SI’s do not always agree. 

Our informal check on motor vehicle prices suggests that this item will decline by 0.5% in the April CPI measurement (-0.02% CPI effect). If the forecast materialises, vehicle prices will have fallen by 2.5% since Q3/2014, owing largely to the reduction in value-added tax at the end of 2014 and the nearly 4% appreciation of the ISK against the euro during this period. 

Actually, there are few components that we expect to have a strong upward effect on the CPI this time. That said, we do expect the hotel and restaurant component to rise by 0.7% (0.03% CPI effect), including a 3.0% increase in hotel accommodation. 

Inflation at target by end-2015

We forecast a modest rise in the CPI in coming months, with only marginal changes in the twelve-month pace of inflation. We project a 0.2% rise in the CPI in May, a 0.4% rise in June, and a 0.3% decline in July, giving an average of 1.5% in Q2/2015. As in April, we expect a relatively uneventful CPI measurement during these three months, as the ISK is quite stable these days, foreign fuel prices have grown less volatile, and wage negotiations look set to be a drawn-out affair, perhaps lasting well into the summer. On the other hand, we expect house prices to push the CPI up by 0.1% per month in the near term. We also expect airfares to rise in June and July, the peak travel season. For July, we anticipate the usual dampening effects of summer sales. 

We project that inflation will begin rising thereafter, aligning with the CBI’s 2.5% inflation target by the end of the year and rising to 2.8% by the end of 2016. The main reasons for our forecast of increased inflation are rapid pay rises and continued housing inflation, both of which reflect the growing tension in the economy and labour market. Inflation could prove higher than we have projected, however. Wages could rise more rapidly than we anticipate, house prices could increase more than we expect, and last but certainly not least, the ISK could fluctuate when (and if) sizeable steps are taken to lift the capital controls.

ISB Research inflation forecast