Rise in housing component set to lose pace

We project that imputed rent will rise by 0.4% month-on-month (0.08% CPI effect). This is a somewhat smaller increase than we have seen in recent months, apart from July, when the MoM rise measured 0.46%. The slowdown stems mainly from the recent easing of pressures in the rental market, together with smaller indexation-related rent hikes. A large share of this month’s decline in headline inflation is due to base effects from imputed rent, which rose by 2% MoM in October 2023. In the near future, the outlook is for imputed rent to rise more gradually than in the recent past – most likely by 1% per month or less.

Airfares the strongest upward-pushing item

After tumbling in September, airfares look set for a partial rebound in October, according to our forecast. Although this is part of the typical seasonal fluctuation in airfares, the cycle is usually not as clearly visible in October as in other months. We forecast that airfares will rise by an estimated 6.8% MoM (0.12% CPI effect), thereby weighing heaviest in the October increase in the CPI. We expect them to decline again in November and then reverse course once more in December – again, following the seasonal pattern.

Another subcomponent of travel and transport – fuel prices – will keep falling in October, according to our measurements. This month’s decline will not be a large one, however – only 0.1% (-0.003% CPI effect) – and will therefore have a negligible impact on the CPI. Uncertainty about the next few months’ developments in fuel prices has mounted, though, as the war in the Middle East has pushed global oil prices higher. In the past few weeks, oil prices have surged more than 10%, and the risk of higher fuel prices has therefore grown.

Food prices rise after falling in recent months

Food and beverage prices are projected to rise MoM by 0.5% (0.08% CPI effect), thereby contributing the same amount as imputed rent, according to our forecast. The increase comes in the wake of price reductions in August and September, but it should be noted that had prices soared during the months beforehand. We think September saw the last major impact from the entry of a new grocery store into the market – at least for the time being.

What lies ahead?

Price level movements in Iceland’s main trading partner countries have been favourable in recent months, and in the eurozone, inflation dipped below target in September. The outlook is for this to continue, and for inflation to hover close to target levels in many economies in the coming term. Another factor is the appreciation of the ISK in recent weeks, which, together with favourable developments in foreign prices, should contribute to disinflation in Iceland later on.

The main short-term uncertainty is the impact on the CPI of the cancellation of oil taxes and the adoption of a per-kilometre charge on motor vehicles, set to take effect at the turn of the year. The effects will probably depend on the classification of the per-kilometre charge. If it is earmarked for transportation projects, its impact on Treasury finances will be negligible. If it is not earmarked, however, and is treated as any other direct tax by SI, we expect it to affect the CPI strongly. According to our estimate – which, of course, is highly uncertain – the changes could lower the CPI by 1.2% in January, causing headline inflation to fall to 3.8% that month. The impact can be seen in the chart below.

It is still too soon to predict with any certainty what effect the changes will have, as it is not yet clear how they will be implemented. Our preliminary forecast is as follows:

• November – CPI to rise 0.2% (twelve-month inflation 4.9%)
• December – CPI to rise 0.4% (twelve-month inflation 4.9%)
• January – CPI to fall by 0.1% (twelve-month inflation 5.0%)

It is worth stressing that the January 2025 figure is based on the assumption that the above-described changes in taxation of motor vehicles will not affect SI’s CPI calculations. In order for our forecast to materialise, both wage drift and the impact of war on commodity prices must be limited and the ISK exchange rate must remain stable. Thus far, the probability of significant wage drift has fallen with reduced tension in the labour market, and the ISK has held broadly steady; therefore, wage drift and import prices do not give cause for particular concern at present. That being the case, favourable import prices and moderate pay rises should contribute to continued disinflation. We think there is a good chance of another policy rate cut in November if our forecast materialises.

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