We forecast a 0.2% decline in the CPI in November

We project that the consumer price index (CPI) will fall by 0.2 % month-on-month in November. In spite of the decline, headline inflation will rise from 1.8% to 2.1% if the forecast materialises, as the CPI fell by 0.5% in November 2014. If this projection is borne out, inflation will remain below the Central Bank’s (CBI) 2.5% inflation target. 

The short-term inflation outlook has improved somewhat from our last forecast, although the medium-term outlook is broadly unchanged. We expect inflation to be somewhat below the CBI’s inflation target at the end of the year. The outlook is for inflation to rise as 2016 progresses. According to our forecast, it will be close to the inflation target, on average, in 2016 and just below the upper deviation limit in 2017. Statistics Iceland (SI) is scheduled to publish its November CPI measurement at 9:00 hrs. on 26 November. 

Changed outlook for November CPI measurement

Our forecast of a 0.2% decline in the CPI in November represents a significant departure from our preliminary forecast of a 0.1% increase. The change stems from four main items: clothing and footwear, travel and transport, food and beverages, and housing, the first three of which are the main drivers of the decline we are forecasting at this time. 

Airfares are the single largest downward-pulling item in our current forecast. Our survey indicates that the air travel component will lower the CPI by 0.14% in November. Seasonal factors weigh heavily, of course, and a stronger ISK, lower fuel prices, and increased competition have some effect as well. 

In recent weeks, an increasing number of clothing stores have gotten a head start on the upcoming cancellation of the 15% excise tax on clothing and footwear set to take effect at the turn of the year, by announcing commensurate discounts from now until the year-end. We expect the clothing and footwear component of the CPI to fall by over 2% in November, lowering the index by 0.10%. The price of various food and beverage items has fallen in the recent term, reflecting the appreciation of the ISK, and we expect the price of vegetables to fall somewhat after sizeable price hikes in recent months. The drop in food and beverage prices will lower the CPI by 0.05%, according to our forecast. 

In keeping with the pattern of the past few months, the housing component of the CPI has the strongest upward impact in our November forecast. The total effect is to raise the index by 0.08%. Of that amount, we expect a 0.4% rise in imputed rent (0.06% CPI effect) and a similar rise in paid rent (0.02% CPI effect). Other components carry less weight, and their combined impact on the CPI is negligible in the forecast. 
Stormy times ahead for the CPI 

In coming months, we expect something of a zig-zag pattern of rising and falling CPI measurements. We anticipate a 0.2% rise in December, followed by a 0.6% drop in January and then a 0.6% increase in February. According to the forecast, inflation will measure 2.0% at the end of the year and 2.1% in February 2016. 

In December, the main items pushing upwards will include food and air transport, both of which have a tendency to rise during the holiday season. The January CPI measurement is generally affected by the tug-of-war between annual price list increases and winter sales. We expect the latter to have the upper hand this time, with help from declining airfares and the final effects of the above-mentioned excise tax cancellation. February always sees considerable upward pressure on the CPI, owing to end-of-sale effects, which we expect to follow more or less the usual pattern. In addition, we expect rising house prices – both purchases and rental – to raise the CPI by just over 0.1% each month during the period. 

Rising inflation on the horizon

We expect inflation to gain pace somewhat as 2016 passes, rising above the 2.5% inflation target in Q3 and measuring 3.6% at the year-end. We expect it to fall back slightly to 3.5% by the end of 2017. The main drivers of rising inflation are strong domestic cost pressures caused by generous wage agreements and the overall heating-up of the economy. Furthermore, the deflation caused by imported goods will taper off, according to our forecast, as we assume that the exchange rate will hold stable throughout the forecast horizon and that global goods prices will rise marginally. 

As usual, the ISK is the main uncertainty in our forecast. For the short term, it appears more likely to strengthen than to weaken, owing to persistent capital inflows in the recent term and the prospect that the settlement of the failed banks’ estates and the release of offshore ISK will not cause substantial foreign currency outflows. Additional appreciation of the ISK could prove cold comfort, however. In our opinion, a further rise in the real exchange rate will undermine Iceland’s competitive position and exacerbate the risk of a steep drop later on. Moreover, wages could rise faster in the near future than we expect, contributing to higher inflation in coming years.

November forecast