Summer sales, ISK appreciation, and sharp drop in petrol prices
This month's decline in the CPI is attributable in large measure to summer sales, which are in full swing at present. Clothing and footwear prices fell by 10.3% between June and July (-0.68% CPI effect). This is a somewhat more pronounced decline than we had expected, and much more than has been seen in the past two years' summer sales. The stronger ISK exchange rate must be a prominent factor here, amplifying the effect of the sales. The relative strength of the króna can be seen in all components of the CPI that are affected by exchange rate developments; for example, furniture, household equipment, and spare parts have declined marginally, as have alcoholic beverages and tobacco. Since the beginning of May, the ISK has appreciated by 6% against major currencies, but the pass-through to price levels varies depending on product category. Exchange rate movements penetrate most quickly to the fastest-moving product categories. Fuel declined in price by 5.91% between June and July (-0.05% CPI effect).

The housing component of the CPI rose in June. The 0.33% rise in the component as a whole is due to a 0.48% increase in imputed rent (which reflects price trends in the residential housing market) and a 0.91% increase in maintenance costs. Paid rent declined by 0.54%, however, effectively nullifying the effect on the month's CPI value.

Provided that the ISK holds stable and does not soften once again, inflationary pressures will probably be limited for the remainder of the summer. It is safe to assume that the drop in petrol prices will reverse, at least to a degree, as will summer sale effects; however, such a trend depends in part on the exchange rate, and a stable currency will tend to hinder the reversal. 


Pessimism on the decline

The index measures consumers' expectations concerning the economy and the labour market: when it is below 100 points, pessimistic sentiment outweighs optimistic sentiment. It has remained below 100 continuously since February 2008 but has risen for the past four months, indicating that Icelanders are more upbeat than before and more certain that the worst is over and better times on the horizon. This trend accords with a number of indicators suggesting that the recession has indeed hit bottom: the labour market appears to be rallying, inflation is abating, the króna has appreciated, interest rates are down, real wages have risen, and GDP growth has turned positive once again.