Our forecast: CPI to rise 0.3% in November

We project that the consumer price index (CPI) will rise by 0.3% month-on-month in November, raising headline inflation from 2.8% to 3.3%. The inflation outlook for the next few quarters has worsened slightly, in our opinion, because of the recent depreciation of the ISK and the prospect of larger pay increases next year than had previously been expected. The outlook is for inflation to measure 3.5% at the end of 2018 and average 3.7% in 2019 before falling slightly, to an average of 3.2% in 2020. Statistics Iceland (SI) is scheduled to publish its November CPI measurement on 29 November. 

ISK depreciation shows in rising prices

Since the end of August, the ISK has depreciated by over 11% in trade-weighted terms. Such a significant change inevitably affects consumer prices unless there is a general expectation that it will reverse quickly. No such expectation appears to be in the cards at present, though. In fact,  imported goods prices have already begun to rise in response to the weaker currency, and it is they that are the main driver of the rise in the CPI.This exchange rate pass-through shows most clearly in goods with a short shelf life. For example, we expect food prices to rise by nearly 0.9% in the November CPI measurement (0.10% CPI effect), owing primarily to imported items. Furthermore, we expect motor vehicle prices to push the CPI upwards by 0.06%, clothing prices by 0.04%, drugs and medical products another 0.04%, and computer equipment and recreational goods by 0.3%.

The real estate market is still quite lively even though house price inflation has eased, particularly in the capital area. We expect imputed rent (by and large a reflection of house prices) to rise by 0.5% (0.11% CPI effect) and other housing-related items to push the index up by 0.04%. 

Airfares and petrol prices pull downwards

Two items stand out among those projected to lower the CPI in November: airfares and petrol. Airfares usually fall in November, and our survey suggests that this year will be no exception. We project the decline in the component as a whole at 12% (-0.16% CPI effect). Furthermore, global fuel prices have fallen by over a fifth since the beginning of October and have begun to affect prices in Iceland, ISK depreciation notwithstanding (-0.06% CPI effect).

Inflation on an upward path in coming quarters

The more than 11% depreciation of the ISK since the beginning of September has changed the short-term inflation outlook distinctly for the worse. We expect the CPI to rise by 0.5% in December, followed by a 0.1% decline in January and an increase of 0.7% in February. If this forecast materialises, inflation will measure 3.5% at the year-end and 3.6% in February 2019. The above-mentioned exchange rate pass-through will have a marked impact on the CPI in the months to come. January will see the usual tug-of-war between price list hikes and increased public levies, on the one hand, and post-holiday sales, on the other. In February, however, the effects of seasonal sales will reverse to a large degree.

Thereafter, we expect inflation to pick up as 2019 progresses, peaking at 3.8% around mid-year, and then taper off gradually in H2/2019, settling at roughly 3.0% by end-2020. The disinflation in H2/2019 is due primarily to a slower rise in house prices further ahead and a stable ISK, which we expect to hover around the current level for most of the forecast horizon. 

Apart from uncertainty about the ISK in coming quarters, the most prominent uncertainties in the forecast centre on two factors: wages, which could rise faster than we anticipate (see the table above); and house price inflation, which could slow down more than we have assumed in this forecast.