Our forecast: CPI to rise 0.5% in August

We forecast that the consumer price index (CPI) will rise by 0.5% month-on-month in August. If this forecast materialises, inflation will rise from 1.9% to 2.1%, just below the Central Bank’s (CBI) 2.5% inflation target. 

The medium-term inflation outlook is broadly unchanged from our last forecast. We expect inflation to align with the inflation target towards the end of Q3 but to rise above it in the fourth quarter of the year. The outlook is for it to rise thereafter but remain just below 4%, the upper deviation threshold of the target, in coming years. Statistics Iceland (SI) will publish the August CPI at 9:00 hrs. on 27 August. 

End-of-sale effects, housing, and food push the CPI upwards …

This month’s rise in the CPI is driven predominantly by two factors. On the one hand, clothing and footwear prices will rise sharply, as they usually do when summer sales wind down in August. We estimate that this year’s end-of-sale effects will raise the CPI by 0.34%, about the same as last summer. 

On the other hand, the housing component of the CPI will raise the CPI by 0.24%, according to our forecast. There are two main reasons for this. First of all, our survey indicates that imputed rent, which largely reflects the market price of housing, will rise 0.9% in August (0.13% CPI effect), and second, home maintenance costs will rise steeply in the wake of the recent wage agreements (0.08% CPI effect). 

In addition to this, we anticipate a rise of approximately 1.0% in food and beverage prices (0.13% CPI effect). A large share of this increase is due to a sizeable increase in dairy product prices (0.08% CPI effect), which was announced last month and took effect at the beginning of August.

Petrol prices and airfares pull downwards

Items related to travel and transport will have the strongest downward impact on the CPI this month. Oil prices have tumbled in global markets since the beginning of July, and domestic oil companies have followed suit by cutting petrol prices twice since SI carried out its July CPI measurement. The total drop in petrol prices amounts to 3.7% during the period (-0.13% CPI effect). Our survey also indicates that international airfares will drop sharply in the August CPI measurement, following a rise of a third in July (-0.21% CPI effect). Presumably, the decline in airfares is triggered by the combined effects of the fall in petrol prices and seasonal price changes. 

Days grow shorter, inflation rises

We expect inflation to rise as the days grow shorter and the year comes to a close, partly because the period of price stagnation in H2/2015 will drop out of twelve-month CPI measurements. That stagnation was due for the most part to favourable developments in petrol prices, changes in taxes and levies on consumer goods, and relatively modest domestic cost pressures in the wake of moderate wage settlements early in 2014. 

But in addition to this, domestic inflationary pressures are growing strongly at present. A chief cause of this is the hefty pay increases landed by a large segment of the labour market in the recent wage negotiations, although the rise in real house prices and the growing tension in many parts of the economy make an impact as well. We expect these factors to push inflation upwards, in spite of limited imported price pressures, and generate headline inflation figures well above the CBI’s 2.5% target in coming years. 

We anticipate a 0.2% rise in the CPI in each of the next three months, followed by a 0.3% increase in December. According to that forecast, inflation will reach target in September and rise to 3.3% by the year-end. 

It will pick up still further in 2016, rising to 3.7% by the end of that year. According to the forecast, inflation will be just below 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. 

Our assumptions concerning medium-term developments in wages, house prices, and the ISK exchange rate are broadly unchanged from our last forecast. The rising inflation in the forecast is due largely to much more rapid wage increases than can be considered consistent with price stability; indeed, most indicators imply that this situation will continue in the coming term. We also expect house prices to keep rising in real terms, thereby pushing inflation upwards. Finally, we assume that the ISK will remain stable at close to its current level, as it has been virtually unchanged for nearly a year and a half under the CBI’s firm management. However, given that a period of gradual liberalisation of capital controls lies ahead, greater exchange rate volatility can be expected in coming quarters. That said, though, we consider the uncertainty about exchange rate developments to be roughly symmetrical.