Housing component rises unexpectedly

Imputed rent, or the cost of owner-occupied housing, has not fallen since Statistics Iceland (SI) adopted its new calculation method this past summer. As a result, there was some uncertainty about whether our forecasted decline in November would materialise, although most indicators suggested to us that it would. In fact, imputed rent rose by 0.9% (0.17% CPI effect), considerably more than most forecasters expected and far above our own projection of a 0.2% drop. Paid rent increased as well, by 1.87% (0.07%), and the housing component as a whole therefore rose by 0.9% (0.27%). Nonetheless, measurements using the new method have not broken the 1% barrier, and as far as we can tell, they have turned out more favourably on the whole than they would have under the previous method. We expect rises in imputed rent to be relatively limited in the coming term, and we do not rule out the occasional decline.

Paradoxically, while the rise in imputed rent was larger than generally forecast, it still played a leading role in this month’s drop in headline inflation. The explanation lies in base effects: imputed rent rose by 2.08% in November 2023, pushing the CPI upwards by 0.4%. That month now drops out of twelve-month inflation calculations, and even though this November’s measurement gives no particular cause for jubilation, it remains the biggest contributor to the fall in headline inflation.

Lower airfares the main downward-pushing item, with contributions from other items

The annual reduction in airfares was the most prominent downward-pushing item in November, with fares falling 11.7% (-0.23% CPI effect) during the month. It was a larger decline than we had anticipated, but in line with those seen in the past three years. We expect fares to rise again in December, nearly wiping out the November reduction, but this, too, is consistent with the usual pattern. Another subcomponent of the travel and transport component – fuels and lubricants – fell by 0.98% (-0.03%).

Various other CPI subcomponents declined as well, chief among them food and beverages, clothing, and furniture and housewares. Food and beverages fell in price by 0.04% (-0.01%), driven mainly by a drop of 2.54% (-0.03%) in the price of fruit, which had surged in October and has now settled down to an extent.

One-off sale effects were also on display this month, as SI’s price measurement week happened to include Singles Day this year. We had projected relatively moderate price reductions on clothing and footwear, as well as on furniture and housewares, but the declines turned out even more modest than we had predicted: clothing and footwear prices fell by 0.27% (-0.01%) and furniture and housewares prices by 0.06%. The overall downward impact on the CPI was therefore minuscule.

The near-term outlook

We are reasonably optimistic about the near-term inflation outlook. We expect headline inflation to fall below the 4% upper deviation threshold of the CBI’s inflation target in February 2025. Although this month’s jump in imputed rent took us by surprise, we do not consider it a sign of an impending surge. We expect imputed rent to rise moderately in coming months, and we do not exclude the possibility of a decline now and again.

The ISK has been strengthening recently, and we therefore expect imported goods prices to develop rather favourably. The outlook is for inflation to maintain the current pace until February. Our preliminary forecast is as follows:

• December – CPI to rise 0.4% (twelve-month inflation 4.7%)
• January – CPI to fall 0.2% (twelve-month inflation 4.7%)
• February – CPI to rise 0.5% (twelve-month inflation 3.8%)

As before, there are numerous uncertainties. If our forecast is to materialise, the impact of domestic politics and international affairs must be limited, although both could change the situation in coming months. There are several other uncertainties as well, chief among them uncertainty about wage agreements for the public sector workers whose contracts are still pending.