We forecast a 0.2% rise in the CPI in May

We project that the consumer price index (CPI) will rise by 0.2% month-on-month in May. Based on this forecast, headline inflation will measure 2.3% like it did in April. 

In our opinion, the medium-term inflation outlook is broadly unchanged since our last forecast. We expect slightly higher inflation in H2/2018 than in our previous forecast, but the outlook after that is broadly unchanged. As before, the outlook is for inflation to hover around the Central Bank’s (CBI) target through end-2019. Statistics Iceland (SI) will publish the May CPI at 9:00 hrs. on 29 May. 

Housing, petrol, and airfares push upwards

Three components are the main upward-pushing items in the CPI in May: house prices, petrol, and airfares. Our survey indicates that imputed rent, which is based in large part on house prices, could rise by 0.4% in May (0.08% CPI effect). This item has been relatively volatile in recent months, however, and is more uncertain than usual at present. The big picture, however, is that house price inflation has receded markedly from its H1/2017 peak. Including the effects of rent and maintenance, the housing component as a whole raises the CPI by 0.10% in May. 

Domestic petrol prices have risen somewhat in recent weeks. This should come as no surprise, however, given the past few months’ surge in global oil prices. For example, the price per barrel of Brent crude has risen by over 20% in US dollar terms since the beginning of May. We expect SI to measure an increase of nearly 2% in petrol prices in May (0.05% CPI effect). 

Our survey indicates that international airfares will rise by 5% in May (0.06%), after having stayed virtually flat in April. This item has often fallen in May, but this year looks set to be different. 
According to our forecast, there are few items that appear likely to lower the CPI significantly in May. That said, we do expect food prices to fall by 0.2% (-0.02%), not least because of changes in import duties on various food items from the EU. The outlook is also for the price of pharmaceuticals, clothing, and telecommunications services to lower the CPI by 0.01% each in May.

Inflation close to CBI target in coming months

The outlook is for inflation to remain close to the CBI’s 2.5% inflation target in coming months. We forecast a 0.2% rise in the CPI in June, a 0.2% decline in July, and a 0.5% increase in August., leaving headline inflation at 2.6% in August. 

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 the upward impact of housing on the CPI has diminished substantially since May 2017, when the housing component raised the index by an average of 0.32% per month. In July, we expect summer sales to make their usual mark on the CPI, followed by the reverse effect when sales end in August. 

Inflation just above target in the coming term

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 at the top of the forecast indicates. 

We anticipate that inflation will be slightly above the CBI’s inflation target in H2/2018, measure 2.8% at the year-end, and then average 2.8% in 2019. It can therefore be said that according to our forecast, inflation will be within striking distance of 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. If the ISK appreciates concurrent with a moderate rise in house prices, inflation could easily fall back below target. On the other hand, next winter’s wage negotiations are a source of considerable uncertainty. It is conceivable that we are overly optimistic about modest wage rises in the coming term, and if so, inflationary pressures from the labour market turn out stronger than we have projected.