End-of-sale effects a major factor

The main upward-pushing item this month was the clothing and footwear component, which increased 5.9% (0.21% CPI effect), driven by end-of-sale effects after an 8.7% drop in July. The furniture and housewares component rose as well, by 1.3% (0.08%), due to the end of seasonal sales. We found it interesting that this component fell by only 0.4% in July, indicating that sales were very shallow this year.

In addition, the recreation and culture component rose by 0.8% month-on-month (0.08% CPI effect), and food and beverages prices increased by 0.4% (0.05%). The rise in the price of food and beverages was the smallest since September 2022.

The travel and transport component was the leading downward-pushing component this month, falling by 1.3% (-20% CPI effect). [Please check this number. 20% looks very strange!] The main determinants were a 7.6% decline in airfares (-0.18% CPI effect) and a 0.4% drop in motor vehicle prices (-0.02%).

House prices fall

The housing component remained flat MoM, reflecting the offsetting impact of lower imputed rent versus an increase in paid rent, home heating, and electricity prices. The imputed rent subcomponent declined by 0.3% MoM (-0.05%), including a 0.8% decline in house prices and a 0.5% increase in the interest component of imputed rent. Paid rent rose by 0.5% between months (0.02% CPI effect), and heat and electricity prices increased by 1.1% (0.04%).

Closer scrutiny of housing market prices shows that the price of single-family homes in the capital area fell the most, or by 2.7%. Prices in regional Iceland fell by 1.3%, while the price of multi-family dwellings in greater Reykjavík remained flat between months.

Twelve-month house price inflation currently measures 1.9%, its lowest since the beginning of 2011. House prices have now fallen two months in a row, and it is safe to say that the past few months have brought a sharp turnaround in the housing market. At the beginning of the year, for instance, twelve-month house price inflation measured 18.2%.

Near-term inflation outlook

Inflation has changed markedly in composition after peaking early this year. Services explain much of the 7.7% headline inflation rate measured in August, or 2.3%, while imported goods account for another 1.9%. The contribution from the housing component has continued to shrink, to 2% of measured inflation in August, while domestic goods prices contribute another 1.5%.

We project that the contributions from both of these – the housing component and imported goods – will keep contracting in the coming term, and that inflation will stem mainly from domestic goods and services.

We forecast that inflation will measure 7-8% in coming months and then taper off swiftly around the turn of the year. We have revised our preliminary forecast for September onwards, as end-of-sale effects appear to have come largely to the fore in the August measurement. According to our preliminary forecast, the CPI will rise 0.2% in September, 0.3% in October, and 0.2% in November, bringing headline inflation to 7.4% in November. For 2023 as a whole, we expect inflation to average 8.6%.

Pronounced uncertainty remains, of course, and the near-term situation will depend heavily on the housing market and imported inflation. We expect house prices to keep falling, albeit slowly, until the market rebalances in the months to come. If the housing market takes off again, inflation will presumably be higher than is projected here. Further out the forecast horizon, other uncertainties will be come into play. Of particular importance are the next wage negotiations, which are rapidly approaching According to our long-term forecast, inflation will average 5% in 2024 and 3.6% in 2025.