Deteriorating inflation outlook
We expect the consumer price index (CPI) to rise by 0.3% month-on-month in May. If this forecast materialises, inflation will rise from 1.4% to 1.6%, thereby remaining quite a bit below the Central Bank’s (CBI) inflation target.
The inflation outlook has deteriorated markedly since our last forecast, largely due to a revision of the wage assumptions, but also due in part to more rapid rises in house prices. We expect inflation to be below the Central Bank’s (CBI) 2.5% inflation target for most of 2015 but to rise above it in the fourth quarter of the year. The outlook is for inflation to rise thereafter but remain just below 4%, the upper deviation threshold of the target, in coming years. Statistics Iceland (SI) is scheduled to publish the May CPI at 9:00 hrs. on 29 May.
Petrol and housing the main drivers of inflation in May
Increased petrol prices and a rise in the housing component explain two-thirds of the rise in the CPI in May. Even though the strike among public sector lawyers has prevented official registration of most house purchase agreements since the beginning of April, our survey indicates that imputed rent (based largely on a 3M moving average of house prices according to purchase agreements) will rise by approximately 0.5% in May (0.07% CPI effect). Owing to this and the effects of increases in paid rent and maintenance costs, the housing component will raise the CPI by 0.1% in May.
Petrol has risen noticeably in price since the April CPI measurement. Our measurements indicate an increase of 2.4% (0.09% CPI effect) in the wake of rising global oil prices, with the US dollar price of Brent crude oil up 16% year-to-date.
Among other items that will raise the CPI this month is hotel accommodation, which we expect to rise by some 7% as the peak tourist season draws near. This increase, together with a marginal rise in restaurant prices, will raise the CPI by 0.04%. We also forecast an increase of 0.2% in food and beverage prices (0.03% CPI effect). According to our forecast, airfares will fall 1.4%, however, (-0.02% CPI effect). Other components will make less of an impact, pushing the index upwards by a total of 0.05%.
Inflation to gain momentum in the near future
We think it likely that twelve-month inflation bottomed out in Q1/2015 and will rise quite quickly over the remainder of the year. This is due in part to base effects, as inflation was unusually low in the second half of 2014, due to direct and indirect effects of the drop in global oil prices and the anticipated cancellation of excise taxes and reduction in the upper VAT bracket at the end of the year. The CPI declined by 0.1% in the latter half of 2014, in a departure from the pattern of the previous four years, when it had risen by an average of 1.1% in the second half.
The outlook for coming months has changed in favour of a larger rise in the CPI. We project that the index will rise by 0.4% in June, then fall by 0.2% in July, and rise again in August, by 0.4%. If the forecast materialises, inflation will measure 1.8% in August. We expect imputed rent to rise considerably in June, assuming that registration of capital area house purchase agreements resumes. We also expect airfares to rise sharply in June and July and then to fall again in August. As usual, summer sales will affect SI’s CPI measurement in July, and end-of-sale effects will have an offsetting effect in August.
In addition to the aforementioned base effects, the rapid rise in the CPI will affect inflation further ahead. We now forecast considerably higher inflation over the coming 24 months than we did in April. The main difference between the two forecasts is that we have revised the wage assumptions in the forecast sharply upwards, in view of developments in wage negotiations over the past few weeks. We now expect the wage index to rise 8.5% in 2015 and 7.5% in 2016. This assumption is equivalent to a 6.5-7.0% increase in contractual wages in 2015, followed by a 5.5-6.0% rise in 2016. We have also revised our forecast for house prices upwards somewhat, in view of changed wage assumptions and new statistical data.
We therefore expect inflation to rise above the CBI’s inflation target in Q4/2015 and to measure 3.2% at the year-end. Inflation will pick up still further in 2016, rising to 3.8% by the end of the year. According to the forecast, inflation will be close to the upper deviation limit of the inflation target for the majority of the year and will not need much of a push to rise above it. It therefore appears to us that the opportunity to secure low, stable inflation in Iceland following the early 2014 wage agreements has been lost, and that what lies ahead is a situation that is by now only too familiar: inflation well above the level consistent with internal and external economic stability for the long term.