End-of-sale effects the main determinant
End-of-sale effects make their mark on the August CPI measurement, as they often do. July sales have been conventional in all respects, and we assume that the post-sale impact will be in line with the recent pattern as well. We expect clothing and footwear prices to rise by nearly 6% (0.3% CPI effect). There are signs that package tours to points abroad have risen in price (0.05% CPI effect), as it appears that the rainy weather in South Iceland has spurred demand for overseas travel in the latter half of the summer. Food will probably rise slightly in price (0.04% CPI effect), led by fish and agricultural products.
Several large items keep the CPI in check
On the other hand, several large CPI subcomponents that are often highly volatile from month to month will either lower the index or have a neutral effect this month. Among them is the housing component. Indicators imply that house prices remained broadly unchanged between July and August, after rising by 4.5% over the preceding four months combined. Fuel prices have fallen by 1.3% since the July CPI measurement (-0.08% CPI effect), owing to ISK appreciation and declining global market prices. And finally, our analysis suggests that international airfares declined significantly in August. We assume a 4% drop in that component (-0.07% CPI effect), although developments in airfares are always highly uncertain.
Inflation outlook bleaker than before
In our opinion, the inflation outlook for the latter half of the year has deteriorated slightly, and we now expect inflation to measure 4% or higher throughout the year. We project the CPI to rise by 0.5% in September, driven mainly by continued end-of-sale effects (0.35% CPI effect), an increase in the housing component (0.08%), and annual hikes in fees related to educational and recreational activities at the beginning of the new school year (0.08%). For October we expect a 0.4% increase in the index, owing primarily to seasonal rises in winter goods prices (0.1%), seasonal hikes in airfares (0.08%), and the housing component (0.07%). We forecast that inflation will measure 4.0% at the end of Q3 and 4.4% by year-end.
The outlook is for continued considerable inflationary pressures thereafter. Private sector wage agreements will expire at the end of November, and we expect a short-term contract to be negotiated at that time. The new contract will probably be based on the then-current inflation rate, and we consider it likely that labour leaders will be assertive in trying to achieve some increase in purchasing power. Domestic cost pressures on goods and services prices will probably remain in place in coming quarters. We also assume that house prices will continue to rise, in spite of their current sluggishness. And as always, the exchange rate will play a key role in the domestic price level, and we anticipate the presence of an underlying depreciation tendency in the next few years. We expect inflation to average 3.9% next year and measure 4.1% in December 2014.
Source: Islandsbanki bank market research