CPI to rise 0.1% in April

We project that the consumer price index (CPI) will rise by 0.1% month-on-month in April. If this forecast materialises, twelve-month inflation will decline from 2.8% to 2.4%, falling below the Central Bank’s (CBI) inflation target once again. 

The medium-term inflation outlook has improved slightly since our last forecast, owing to the prospect of reduced inflationary pressures in coming months. Further ahead, however, we expect house prices and wage costs to rise somewhat more than we had previously anticipated. As before, the outlook is for inflation to hover around the target through end-2019. Statistics Iceland (SI) will publish the April CPI at 9:00 hrs. on 27 April. 

Housing pushes upwards, airfares downwards

CPI components will change less markedly in April than they have in previous months, according to our forecast. Two components will affect the CPI the most this month, although they will pull in opposite directions: the housing component and airfares.

As in recent months, the housing component will have a strong upward impact on the CPI in April. Our survey indicates that imputed rent – largely a reflection of developments in house prices – will rise by 0.6% during the month (0.12% CPI effect). This item has been quite volatile in the recent past, and it is quite uncertain how it will behave this month. We also expect paid rent to rise by 0.4% in April (0.02% CPI effect) and for the housing component as a whole to push the CPI upwards by 0.14%. 

On the other hand, our survey indicates that international airfares will fall by approximately 11% (-0.11% CPI effect), after a 3% hike in March. If our projections are borne out, overseas airfares will have fallen by about a fifth year-to-date, in spite of the uptick in March. 
We expect other CPI components to have limited effect on the index in April. That said, we expect a 0.2% rise in food prices (0.03% CPI effect) and a 0.4% increase in hotel and restaurant services (0.02%). Pharmaceuticals prices look set to fall slightly, however (-0.02% CPI effect). According to our forecast, other components will have less impact.

Inflation close to CBI target in the near term

The outlook is for inflation to remain close to the CBI’s 2.5% inflation target in coming months. We project a 0.2% rise in the CPI in May, a 0.2% rise in June, and a 0.1% decline in July, leaving headline inflation at 2.5% in July. 

On average, the housing component will be the main driver of the rise in the CPI over the period, contributing about 0.14% per month, although this is a considerably slower rate of increase than we saw a year ago. Presumably, the price of hotel and restaurant services will rise markedly, as will airfares, when the peak tourist season arrives. In July, summer sales will kick in, with the usual effect on the price level. We do not see signs that other components will make a strong impact on the CPI in the next few months, although the general price level will probably trend modestly upwards.

Inflation close to 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. For the rest of the forecast period, we expect the exchange rate to remain close to the average seen in recent quarters. We also expect the housing market to cool over the course of the forecast horizon, although wage pressures will grow steadily, as the table indicates. 

We anticipate that inflation will be close to the CBI’s inflation target in H2/2018, measuring 2.7% at the year-end, and then average 2.6% in 2019. It can therefore be said that according to our forecast, inflation will be quite close to the CBI’s target through end-2019.

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