The ISK has appreciated somewhat since the last inflation measurement, but before then it had weakened because of the effects of COVID-19. We think most of the impact of that depreciation has already passed through to SI’s price measurements, although some price hikes will materialise in June. We project that inflation will remain below the CBI’s target this year, averaging about 2.0% in 2021 and 2.4% in 2022.

Travel and transport contribute most to CPI rise

According to our forecast, the travel and transport component will weigh heaviest in this month’s increase in the CPI, rising by 0.8% (0.12% CPI effect) between months. Motor vehicle prices are set to rise by 0.7% (0.04%), after a largely exchange rate pass-through-induced increase of nearly 7% in the past three months. Petrol prices are expected to rise by 0.5% (0.02%), the first increase of the year, after falling by nearly 13% over the past four months.

We also expect international airfares to rise by 3% month-on-month, after remaining flat for two months featuring virtually no flight offerings. But it is still difficult to predict how airfares will develop, as flights are still in short supply. The coming months will probably see a change, however, as borders open and demand picks up.

Other items that we expect to rise between months include food and beverages (0.08% CPI effect), especially dairy products, which will increase following the pricing committee’s decision to raise wholesale prices and the minimum price of milk. Clothing and footwear prices also look set to rise (0.05% CPI effect), as will furniture and housewares (0.06% CPI effect).

Housing component the main downward-pushing item

The main counterweight to June price increases comes from the housing component, which we project to decline by 0.3% (-0.10% CPI effect). The main downward-pushing subcomponent of housing is maintenance and repair, which is based primarily on the Building Cost Index. We forecast that this subcomponent will fall by 1.5% (-0.08% CPI effect), as the Building Cost Index fell markedly MoM in June. The main reason for the decline is the labour component, which will fall significantly because of the Government’s temporary pandemic response measures. Among these is the reimbursement of 100% of value-added tax on the labour component of residential construction, up from the previous 60%.

Imputed rent fell by 0.6% in May, and we expect it to fall by 0.15% (-0.02%) in June. In our opinion, the impact of COVID-19 has begun to show in the housing market; indeed, we view SI’s price measurements for May as an indication of that impact. The June measurement is based on purchase agreements made in March-May. We expect that measurement and those to follow to shed further light on the pandemic’s short-term impact on the housing market.

Inflation moderate in the coming term

The inflation outlook for the next few months is reasonably favourable. We expect the CPI to fall by 0.2% in July, and then rise again in August and September, by 0.2% in both months. If our forecast materialises, headline inflation will measure 2.5% in September. Thereafter, we expect inflation to remain moderate throughout the forecast horizon and to be below the CBI’s inflation target in both 2021 and 2022.

Obviously, uncertainty is considerable at present, with the ISK among the leading uncertainties in our forecast. The reason inflation has not taken off in spite of the ISK depreciation in March and April is that various other factors, including oil prices and house prices, have pulled in the opposite direction. By now, we believe the depreciation has surfaced more or less in full, and the main assumption underlying our long-term forecast is that the ISK will remain broadly stable at the current level. If it starts to slide further, imported goods prices will rise more than is forecast here. That said, later this year, house prices could end up curbing inflation even more than we expect.

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