House price inflation eases, but the interest component packs a punch

The housing component has been a major driver of developments in the CPI in recent months. House prices have started coasting slightly higher once again, and the interest component has continued to buoy them up. They have risen by 2.5% in the past three months, after falling slightly in the months beforehand. SI’s price measurements are based on three-month averages, and data on housing market turnover and the number of contracts finalised suggest that activity was lively in March.

According to our measurements, house prices will rise much more slowly in June than in previous months. We forecast that imputed rent will rise by 1.0% (0.19% CPI effect) month-on-month, with the market price of housing up 0.3% and the interest component pushing upwards by another 0.7%.

Will imported inflation ease?

Apart from housing, the travel and transport component is the main driver of inflation in June, owing chiefly to a 7.3% rise in airfares (0.15% CPI effect), part of the usual seasonal pattern. Our measurements suggest that fuel and motor vehicle prices will remain flat MoM

and that food and beverage prices will rise more slowly in June than in previous months. We expect the food/beverage component to rise by 0.65% (0.10%) MoM, which would be the smallest monthly increase since last September. Food prices have soared in the recent term and are up 7% in 2023 to date. The expectation of a slowdown in June could be a sign that food price inflation will ease in the near future. It has done so in many other countries and, all else being equal, will follow suit in Iceland.

Other key upward-pushing items in June are hotels and restaurants, up 1.3% (0.07%); clothing and footwear, up 1.0% (0.04%); and furniture and housewares, up 0.6% (0.04%).

The near-term outlook

Twelve-month inflation finally fell in May, to 9.5%. We expect it to continue downwards in the coming term. We forecast that the CPI will rise by 0.3% in both July and August, and by 0.4% in September, leaving headline inflation at 8.1% in September.

We have said repeatedly that when the housing market cools and imported inflation loses momentum, twelve-month inflation will fall rapidly from the recent level. This remains the premise for our short-term forecast, as these two items account for some 5.5% of overall inflation at present. It goes virtually without saying that the situation is highly uncertain and the risk profile tilted to the upside.

Although the outlook is for inflation to fall quickly, there is a long road yet to travel before it can be brought back to target. According to our long-term forecast, it will average 8.7% in 2023, 5.4% in 2024, and 3.7% in 2025. The main assumption underlying our long-term forecast is that upcoming wage negotiations will result in more modest pay rises, as wage agreements will probably play an important role in price stability over the next several years.

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