Our forecast: 0.6% rise in CPI in February

We project that the consumer price index (CPI) will rise by 0.6% month-on-month in February, lowering headline inflation from 2.4% to 2.2%. 

The medium-term inflation outlook is broadly unchanged from our last forecast, with the base effects from higher-than-expected inflation in January offset by a slowdown in wage growth and house price inflation. This accords with the assumption in our recent macroeconomic forecast. As before, the outlook is for inflation to hover around the Central Bank’s (CBI) 2.5% target through end-2019. Statistics Iceland (SI) will publish the February CPI at 9:00 hrs. on 27 February. 

End-of-sale effects and airfares pull against house prices

As is usual in February, end-of-sale effects weigh heavily in the CPI rise in this forecast, as post-holiday sales pulled the CPI significantly downwards in January. The end of winter sales will have the strongest impact on the price of furniture, electronic equipment, and housewares (0.20% CPI effect) and clothing and footwear (0.15%). 
Furthermore, our survey indicates that overseas airfares will rise markedly, after a nearly 9% drop in January (0.13%). 

These items explain the majority of the CPI increase we forecast for February, although paid rent (0.02% CPI effect), petrol (0.02%), and recreation and culture (0.07%) will have some impact as well. 

In a new twist, the item pulling most strongly downwards in this forecast is house prices. Our survey suggests that imputed rent, which is based largely on housing market prices, will decline in February (-0.05% CPI effect). It is well to remember, however, that this item has been rather unpredictable in recent months, with Statistics Iceland’s (SI) most recent house price measurements diverging widely from our surveys and other forecasters’ projections. As a result, the impact of imputed rent in this forecast is much more uncertain than usual. 

In addition to the decline in imputed rent, we expect motor vehicle prices to fall slightly (-0.02%). Apart from these, however, there are few downward-pulling items in our forecast. We expect food and beverage prices to remain virtually unchanged after the past few months’ rise. 

Inflation close to CBI target in the near term

The outlook is for inflation to hold broadly steady in coming months. We expect the CPI to rise by 0.4% in March, 0.3% in April, and 0.2% in May, leaving headline inflation at 2.4% by May. 

On average, the housing component will be the main driver of the rise in the CPI over the period, contributing about 0.11% per month, although this is a much slower rate of increase than we saw a year ago. End-of-sale effects will have their usual impact on inflation measurements in March, and accommodation and restaurant services prices will presumably rise as the summer approaches. We do not see signs that other components will strongly affect the CPI in the next few months, although the general price level will probably trend modestly upwards.

Inflation slightly above target in coming years

The outlook is for domestic inflation to remain moderate over the forecast horizon, as long as the ISK does not weaken unduly. We expect the exchange rate to stay close to its recent average for the rest of the forecast period. We also expect the housing market to cool and wage pressures to ease as the forecast period progresses, as the table indicates. 

We assume that inflation will be in line with the CBI’s 2.5% inflation target through the autumn and then rise somewhat, to about 2.9% by the end of the year. For 2019, we project it to average 2.7%. It can therefore be said that according to our forecast, inflation will be close to target, on average, through end-2019.

There is considerable uncertainty about near-term house price developments, however, given the recent changes in the housing market. We consider this the main downside risk to our forecast. On the other hand, the rapid rise in wage costs could prove more persistent over time than we have assumed. And as always, the ISK exchange rate is uncertain. 

Inflation forecast February 2018