CPI to decline 0.6% in January

We project that the consumer price index (CPI) will fall by 0.6% month-on-month in January, leaving headline inflation unchanged at 1.9%. Inflation has therefore been below the Central Bank’s (CBI) 2.5% inflation target for three years running. 

In our view, the medium-term inflation outlook has deteriorated slightly since our last forecast. This is due both to a somewhat larger rise in the CPI in coming months than we had previously anticipated and to a slightly lower average ISK exchange rate. We continue to assume, however, that inflation will be modest in the short run, remaining below the inflation target until Q2/2018. It will rise quite swiftly thereafter, though, approaching the 4.0% upper deviation threshold of the target in Q4/2018 before subsiding once again. Statistics Iceland (SI) will publish the CPI for the month at 9:00 hrs. on 27 January.

Housing, petrol, alcoholic beverages, and tobacco push the CPI upwards

The housing component of the CPI has been the strongest upward-pushing component of the index in recent months, and we expect it to remain so this time. Our survey indicates that imputed rent – largely a reflection of developments in house prices – will rise by 1.3% during the month (0.21% CPI effect). Reduced utilities and maintenance costs will slightly offset these effects, however, and the housing component as a whole will raise the index by 0.20%. 

Domestic petrol prices have risen significantly in the recent past, in response to a spike in global oil prices early in December, and various public levies have risen as a result. The average increase since SI’s last measurement is 3.8% (0.14% CPI effect), according to our survey.
Alcohol and tobacco prices rose at the turn of the year because of an increase in public levies, raising the CPI by 0.09%, according to our forecast. Rising food prices will raise the index by 0.06%, mainly because of an increase in dairy product prices (0.05% CPI effect) at the beginning of January. Furthermore, we expect an increase in hotel and restaurant services prices, which will raise the CPI by 0.05%, according to our forecast. 

Sale effects, airfares, and motor vehicle prices pull downwards

As usual, seasonal sales have a strong downward impact on the CPI in January. We expect clothing and footwear sales to lower the index by 0.58% and furniture and home appliance sales to lower it by 0.24%. As the chart shows, the overall impact is comparable to that in recent years. In addition, a decline in the price of television sets, computers, and stereo equipment will lower the index by 0.06%, according to the forecast. 

We also expect reduced airfares to lower the CPI by 0.10% this month. This item is somewhat uncertain, however, as our forecast for December turned out very different from SI's actual measurements. Furthermore, our price survey indicates that the price of new motor vehicles has fallen significantly in recent weeks, which should lower the CPI by 0.15% this month. If this projection materialises, vehicle prices will have fallen by nearly 7% since mid-2016. 

Inflation broadly unchanged in coming months

The outlook is for inflation to remain broadly unchanged in the next few months. We expect the CPI to rise by 0.6% in February, 0.5% in March, and 0.3% in April. According to these projections, inflation will measure 2.0% in April. 

On average, the housing component will be the main driver of the rise in the CPI over the period, contributing about 0.18% per month. In February and March, seasonal sale effects will reverse for the most part, although we do expect the price of imported goods such as clothing, furniture, and electrical appliances to be generally lower at the end of the quarter, owing to a stronger ISK and the cancellation of import duties on some of these goods. We also expect airfares to fall in February and then rise again in March and April. And finally, food and beverage prices will pull the CPI downwards in February. 

Inflation to remain below target through spring 2018

The outlook is for domestic inflation to remain moderate over the forecast horizon, as long as the ISK does not weaken again. We expect it to average 1.8% in 2017 and to measure 1.9% by the end of that year. We project that it will pick up thereafter, overtaking the Central Bank’s (CBI) 2.5% inflation target in Q2/2018 and hovering near 4.0%, the upper deviation threshold of the target, in the fourth quarter of the year. We are now publishing our first forecast for 2019, which assumes that inflation will taper off again during that year, to 3.3% by the end of the forecast horizon. The uncertainty in the forecast naturally increases further out the horizon, however. 

As before, the ISK exchange rate provides the fulcrum for our forecast, and we still expect the ISK to appreciate until Q4/2017, by a total of nearly 8% from the current level. However, because the ISK has weakened since our last forecast, it will not rise to the level we projected in our December forecast. As before, we assume that the exchange rate will fall gradually over the latter part of the forecast horizon, as the trade surplus narrows and the effects of a high real exchange rate grow stronger. In spite of this, it will be somewhat above the current level by end-2019 if our forecast materialises. 

Wage hikes will continue to put upward pressure on domestic prices, as we assume that wages will rise somewhat faster than is consistent with the inflation target plus productivity growth. That pressure will gradually ease over time, however, as tension in the labour market subsides. We expect house prices to follow a similar pattern, continuing to rise but at an increasingly slower pace.