The ISK has depreciated by 1.3% in the past month, falling to its weakest against the euro since 2013, yet inflation remains relatively stable. We expect it to remain close to its current level and do not anticipate a significant exchange rate-induced inflation spike. The Central Bank of Iceland has been active in the foreign exchange market in the recent term and has kept the exchange rate broadly stable in the past five months. We forecast that inflation will average 2.6% in 2020, 2.3% in 2021, and 2.5% in 2022.
Inflation set to remain above target
We project that the consumer price index (CPI) will rise by 0.15% month-on-month in August, and that twelve-month inflation will measure 2.8%, down from 3.0% in July. If this forecast materialises, inflation will have remained above the Central Bank’s (CBI) target for the second month in a row. The outlook is for it to hover just above target in the near term.
Summary
We forecast a 0.15% rise in the CPI in August
Airfares rise between months.
Additional sales in August keep inflation in check.
Inflation still moderate despite a significantly weaker ISK.
Petrol prices continue to rise after a steep drop earlier this year.
Clothing and footwear prices push the CPI downwards.
Summer sales still pushing the CPI downwards
Last month, seasonal sales had a weaker impact on the CPI than in recent years, and we expect the clothing and footwear component to lower fall by 3.8% in August, lowering the CPI by -0.14%. Demand for flights has increased marginally in the recent past, after lying virtually dormant this summer. Airfares weighted heaviest among upward-pushing items in August, rising 1.2% MoM in August (0.18% CPI effect). Petrol prices will continue to rise (1.1%; 0.03% CPI effect), after having fallen considerably early this year.
Furniture and housewares will fall in price, owing to sales (-0.04% CPI effect), with the seasonal sale effect apparently spread over both July and August. The imputed rent component will also rise between months, while historically low interest rates have contained real house prices.
Inflation to remain above target
The outlook is for inflation to measure just above the CBI’s target in coming months, which is quite favourable under current circumstances. We forecast that the CPI will rise by 0.2% in September, 0.2% in October, and 0.1% in November. If these projections are borne out, inflation will remain modest, measuring 3.0% in September and 2.8% in both October and November. Thereafter, we expect it to remain close to the CBI’s inflation target in both 2021 and 2022.
There is considerable uncertainty afoot, however, owing to a resurgence of COVID-19 infections, and it is difficult to say what the future holds. We remain relatively optimistic, though, and we base our projections on the belief that the recent domestic COVID outbreak has been brought under control. If it turns out that cross-border travel has to be restricted again, this could cause the ISK to weaken once more, which in turn could trigger higher inflation.
Author
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