Highest inflation in a year

Inflation now measures 2.2% in Iceland, the highest level seen since August 2014. That notwithstanding, inflation is below the Central Bank’s (CBI) 2.5% inflation target, as it has been for the past 19 months straight. The outlook is for a steady increase over the next few months and an inflation rate well above the target by the year-end. 

According to figures released recently by Statistics Iceland (SI), the consumer price index (CPI) rose 0.53% month-on-month in August, well in line with our forecast of a 0.5% rise. Official forecasts provided for an increase in the 0.1-0.5% range. Twelve-month inflation rose sharply during the month, from 1.9% in July to the current measurement of 2.2%. In terms of the CPI excluding the housing component, twelve-month inflation measures only 0.7%, although this, too, is represents a steep increase from the 0.4% measured in July. 

End-of-sale effects and groceries push the CPI upwards

As is customary in August, end-of-sale effects pushed the CPI upwards, although less strongly than we had anticipated. Clothing and footwear prices rose 5.4% (0.21% CPI effect), somewhat less than in August 2013 and 2014. Food prices also rose in August, with the food and beverage component of the CPI up 1.1% month-on-month (0.16% CPI effect). As expected, the rise in food and other dairy product prices played a leading role in the increase (0.09% CPI effect). 

Housing costs rise on the back of wage settlements

The housing component of the CPI rose by 0.5% in August (0.14% CPI effect). Of that total, imputed rent, which mainly reflects developments in residential real estate prices, rose by 0.3% (CPI effect 0.04%), and paid rent rose by 0.4% (0.01% CPI effect). As we had expected, home maintenance costs were up sharply, with the maintenance component rising 3.0% between July and August (0.08% CPI effect). That increase is due to an 11.6% increase in maintenance services, which in turn is due to the newly concluded wage agreements for tradesmen and construction workers. 

Travel component declines

The travel and transport component of the CPI declined by 1.1% MoM (-0.17% CPI effect) in August, owing predominantly to a 4% decline in fuel prices (-0.15% CPI effect). In addition, motor vehicles declined in price by 0.4% (-0.02% CPI effect), and air transport by 1.0% (-0.02% CPI effect). As regards the latter of these, developments in both domestic and international air travel were much less favourable than expected. The drop in international airfares was much more modest than we had anticipated, at only 3.4%, and domestic flights jumped a full 32.4%, although the domestic air travel component weighs much less in the CPI than overseas air travel does. 

Reduced near-term inflationary pressures

Near-term inflationary pressures could turn out weaker than we had assumed, owing to the drop in fuel and commodity prices over the past few weeks. In addition to the effect on fuel prices in the CPI, the steep decline in commodities could affect the price of items ranging from airfares to imported food. Imported deflation could therefore offset domestic cost price increases in coming months, particularly in view of the appreciation of the króna since mid-year. 

We have already revised our preliminary September forecast downwards, and we now assume that the CPI will be virtually unchanged during the month instead of rising 0.2%, as we had previously projected. The downward revision is due mainly to domestic fuel prices, which have already fallen 4.4% since SI conducted its August CPI measurement (-0.16% CPI effect), with additional price cuts highly likely further ahead. Apart from this, IKEA’s 2.8% price reduction, announced after we had prepared our preliminary forecast, can be expected to affect the furniture component in September. According to the present forecast – also a preliminary one – twelve-month inflation will rise from this month’s 2.2% to 2.3% in September. 

Steadily rising inflation 

For October and November, we expect a 0.2% increase in the index each month. If this forecast materialises, twelve-month inflation will measure 2.3% in October and then shoot up to 3.1% in November, well above the CBI’s inflation target. The steep rise in November is due largely to base effects, as the CPI fell by an unexpected 0.5% in November 2014, mainly due to a surprise drop in house prices and a larger-than-expected fall in various imported goods prices.