We forecast a 0.2% rise in the CPI in March

We project that the consumer price index (CPI) will rise by 0.2% month-on-month in March. If this forecast materialises, headline inflation will fall from 1.9% to 1.8%. 

In our opinion, the medium-term inflation outlook has improved somewhat since our last forecast. One of the main reasons for this is that we expect the ISK to be noticeably stronger over the forecast horizon than we had previously thought. Furthermore, we expect a smaller rise in the CPI in the short run and a smaller rise in wages in 2017. We expect inflation to subside as the year progresses, measuring 1.5% at the year-end, and then pick up once more, overtaking the Central Bank’s (CBI) 2.5% inflation target in Q3/2018 and averaging just over 3.0% in the latter half of the forecast horizon. 

Housing and clothing and footwear push 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 once again. Our survey indicates that imputed rent—largely a reflection of developments in house prices—will rise by 1.5% during the month (0.25% CPI effect). This is broadly in line with developments in recent months. The housing component as a whole will push the index up by 0.26% in March. 

The small increase in clothing and footwear prices in February took us quite by surprise, and we expect a correspondingly larger rise in this CPI component in March. We project that the component as a whole will rise by 5.7% (0.22% CPI effect). In spite of this, clothing and footwear prices will be somewhat lower in March than they were before the winter sales, which we attribute to stiffer competition and the appreciation of the ISK. 
Other items that we expect to rise in price are hotel and restaurant services, which will raise the CPI by 0.04% during the month. 

Petrol, housewares, electrical equipment, and airfares pull downwards

Offsetting the above will be a number of items pulling the CPI downwards in March, chief among them furniture, housewares, and the like (-0.14% CPI effect). The decline in this component stems from two causes: IKEA’s 10% average price reduction, which covers a major share of the items falling into this category, and the unusually large rise in electrical appliance prices in February—much larger than could be explained by end-of-sale effects. We expect that increase to reverse in part this month.

In addition, petrol prices have fallen since the February CPI measurement, owing to a sizeable drop in global oil prices and a strong uptick in the ISK during the intervening month. According to our measurements, the decline is just over 1.9% (-0.07% CPI effect). In addition, our price measurements indicate that airfares have fallen somewhat in March (-0.06% CPI effect). 

Inflation broadly unchanged in coming months

The outlook is for inflation to remain broadly at current levels in the next few months. We expect the CPI to rise by 0.3% in April, 0.3% in May, and 0.1% in June, leaving headline inflation at 1.7% by mid-year. 

On average, the housing component will be the main driver of the rise in the CPI over the period, contributing about 0.16% per month. The hotel and restaurant services item will also push the index upwards in coming months, particularly in May, when the peak tourist season kicks in. We also expect airfares to rise in April and June but to taper off in May. Furthermore, stiffening competition in the petrol market could affect prices, and we therefore expect a decline in June. We also expect falling food and furniture prices, among other things, to have an impact in June. 

Inflation below target until H2/2018

The outlook is for domestic inflation to remain moderate over the forecast horizon, as long as the ISK does not weaken again. Actually, we expect inflation to lose pace in the latter half of the year, not least in response to the rapid appreciation of the ISK over the summer months. We expect it to average 1.6% in 2017 and to measure 1.5% by the end of the year. We project that it will pick up thereafter, surpassing the CBI’s 2.5% inflation target in Q3/2018 and remaining above the target through the end of 2019. We project average inflation at 2.5% in 2018 and 3.3% in 2019. The uncertainty in the forecast naturally increases further out the horizon, however. 

As usual, the ISK exchange rate is the main determinant in our forecast, and we still expect the ISK to appreciate until the last quarter of this year. We project a rise of nearly 8% from the current level. 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 high real exchange rate makes its presence felt. That said, the ISK is somewhat stronger, on average, in this forecast than in our last one. 

Wage hikes will continue to put upward pressure on domestic prices, as we assume that wages will rise somewhat more 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. The decision by most labour market agents to postpone their wage settlement review has also mitigated short-term uncertainty about wage developments. We expect house prices to follow a similar pattern, continuing to rise but at an increasingly slower pace.