Airfares set to rise and drug prices to fall during the lead-up to the holidays

Typically, the main inflationary CPI item in December is the annual jump in airfares in response to the surge in demand during the holiday season. According to our forecast, that pattern will hold this year and international airfares will lead the way with an increase of 9% (0.16% CPI effect) in December

Pharmaceuticals prices are set to fall by 2.54% during the month, but they carry little weight in the CPI and will therefore have a negligible impact on headline inflation.

Food and imputed rent contribute in equal measure to the December CPI increase

Our forecast indicates that the contribution of the housing component to inflation will continue to decline. We project that imputed rent will rise by 0.3% (0.05%) this month, after increasing by a surprising 0.9% in November, far above our forecast of a 0.2% drop. The November increase tied with the month of August for the largest rise in imputed rent since Statistics Iceland (SI) adopted its new imputed rent calculation method. Measurements using the new method have yet to break the 1% barrier, and on the whole, the imputed rent subcomponent has been less volatile from month to month since the change was made.

Near-term inflation outlook

We expect the twelve-month pace of inflation to slow markedly from February onwards, as large monthly increases will start dropping out of year-on-year measurements. As 2025 advances, we expect headline inflation to be well below the CBI’s upper deviation threshold, and it should be quite close to the 2.5% target around mid-year. A number of economic variables have developed favourably in recent months: the ISK has strengthened and the rental and housing markets have cooled, which should show in the December inflation measurement, if our forecast is borne out. But as can be seen in the wide divergence between the November imputed rent measurement and forecasters’ projections for the month, it can be difficult to predict changes in the subcomponent during the initial months following the change in methodology, and uncertainty about the months to come has therefore grown more pronounced.

Our preliminary forecast is as follows:

• January – CPI to fall 0.1% (twelve-month inflation 4.8%)
• February – CPI to rise 0.5% (twelve-month inflation 4.0%)
• March – CPI to rise 0.4% (twelve-month inflation 3.5%)

This represents a slightly slower pace of disinflation than we had projected earlier, mainly because public levies are set to increase in January. Nevertheless, we remain optimistic about inflation in 2025, although as usual, there is uncertainty about several underlying variables. The ISK, for instance, must remain relatively stable if the forecast is to materialise. Other uncertainties include domestic politics, the global geopolitical situation, and the outcome of wage negotiations for those public sector workers whose contracts are still outstanding.

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