According to newly published figures from Statistics Iceland (SI), the CPI rose 0.46% month-on-month in July, pushing headline inflation up from 5.8% to 6.3%. Inflation according to the CPI excluding housing measures 4.2%. A fair number of items in this month’s measurement came as a surprise. Seasonal sales were shallower and airfare hikes larger than we had forecast. Imputed rent has unexpectedly been on a downward path recently, however, and the new imputed rent calculation method augurs well for favourable developments in inflation in the coming term.
Inflation spikes unexpectedly in July
Headline inflation took a sudden jump in July, rising once again above 6%. Nevertheless, the outlook for the next few months is quite decent, and we expect twelve-month inflation to measure 5.4% at the year-end. Regularly occurring events such as summer sales and seasonal hikes in airfares pull against one another, but food prices unexpectedly rose in excess of forecasts.
The July measurement is considerably above our forecast of a 0.1% month-on-month rise in the CPI. Other published forecasts were similar to ours. The main difference between our forecasts and SI’s measurements lies in a bigger jump in airfares and food prices, on the one hand, and slightly shallower summer sales, on the other. In addition, imputed rent rose less than we had anticipated.
Housing component well-behaved – for a change
The new method for calculating owner-occupied housing costs (a.k.a. imputed rent) has been effective thus far in dampening the wide month-to-month fluctuations that accompanied the previous method. In the recent past, imputed rent has risen less than we had expected. In July, for instance, it rose by 0.5% (0.09% CPI effect) instead of the 0.8% (0.15% CPI effect) we had forecast. Concerns that the new method would lead to higher inflation have not materialised as yet. In this context, the initial position is highly important, as the new method should result in stickier measurements. As a result, signs of tension in the rental market have not yet shown in imputed rent measurements. Furthermore, a less buoyant summer tourist season could lift some of the pressure off the rental and housing markets over time.
Peak-summer travel costs rise more than indicators had implied
International airfares rose 16.5% (0.34% CPI effect), well above our forecasted 10% increase. While this represents the annual jump generally seen during the summer months, the size of it took us aback, given the contraction in tourist arrivals this summer. Presumably, brisk activity in services to transit passengers explains some of the increase.
Unexpected hop in food prices
The item that outpaced our forecast the most was the food and beverages component, which surged by 1.1% MoM (0.15% CPI effect), far in excess of our projected rise of 0.3% (0.05% CPI effect). Food price inflation currently measures 5.7% year-on-year.
Seasonal sales pack less of a punch than anticipated
Annual summer sales took place as expected, but they were slightly shallower than expected. Clothing and footwear prices fell 6.25% (-0.24% CPI effect), whereas we had forecast a drop of 10.22% (-0.36% CPI effect). Although the price of clothing and footwear declined somewhat in June, too, the combined effect is weaker than projected. In addition, furniture and housewares prices fell by 6.25% (-0.13% CPI effect), overtaking our forecasted 2% decline (-0.04% CPI effect). On the other hand, electrical equipment prices rose 1.68% (0.02% CPI effect), after falling steeply in June. Seasonal sales on these last items may well affect the August CPI measurement. Tepid summer sales are a sign that some underlying inflationary pressures remain in the economy.
Market responses
Thus far today, the breakeven inflation rate in the bond market has risen significantly. In the past few days, it has been tiptoeing downwards, particularly the short-term breakeven rate. The three-year rate is currently hovering around 3.9%, according to our calculations, while the ten-year rate is just over 4.3%. Yesterday, though, the three-year rate was down to 3.6% and the ten-year rate just under 4.2%.
The near-term outlook
In light of this morning’s numbers, we have revised our preliminary inflation forecast upwards, but in our opinion, the short-term outlook for month-to-month movements in the CPI has not changed substantially. We assume the following:
- August – CPI to rise 0.3% (twelve-month inflation 6.2%)
- September – CPI to rise 0.2% (twelve-month inflation 6.1%)
- October – CPI to rise 0.3% (twelve-month inflation 5.7%)
There are a number of uncertainties further ahead. Chief among them is the impact of a more sluggish summer tourist season, which could dampen demand pressures in the economy earlier than previously thought.
Another is the planned introduction of a per-kilometre charge for all motor vehicles and the simultaneous cancellation of excise taxes on petrol and other fuels. The new structure is expected to take effect in January 2025, and the first effects of the change will therefore show in inflation figures for that month.
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