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Unexpected 0.3% drop in CPI
  A marked decline in the housing component, unusually deep sales effects, and a one-fifth drop in international airfares are the chief reasons for the unexpected drop in the consumer price index (CPI) in January. According to Statistics Iceland's figures from today, the CPI dropped by 0.3% month-on-month in January, in the first MoM decline since March 2009. The news contrasted directly with market forecasts of a 0.9-1.3% rise in the CPI, with our own forecast at the bottom end of that range. Inflation therefore measures 6.6%, down from 7.5% in December, in the lowest measurement since January 2008.
CPI drop partly temporary
Imputed rent in the CPI, which reflects the market price of housing plus financing costs, declined by 2.9% in January (-0.37% effect on the CPI). This is the largest monthly drop since March 2009, and is due in very large part to declining market prices, although falling real interest rates also play a role. Clothing and footwear declined by 10% (-0.63% index effect), more or less in line with the sales effect of recent years; however, sales had a more pronounced downward impact on furniture and housewares prices (-0.31% CPI effect) than in recent years. International airfare dropped by over 21% (-0.21% index effect), although this component is extremely volatile at present.
Offsetting these downward pressures are a 1% rise in food and beverage prices (0.14% CPI effect), a 5.7% rise in fuel prices (0.28% CPI effect), a 6.3% hike in alcohol and tobacco prices (0.22% CPI effect), and a 4.3% increase in electricity and heat (0.11% CPI effect). Tax hikes play a leading role here and drive the majority of other increases as well. Price list increases from public and private sector alike, which often press the CPI upwards in January, appear to have been quite modest this year, apart from tax effects.
Substantial rise in February and March
 The constant-tax index, which the Central Bank considers in its interest rate decision, declined by 1.05% month-on-month; thus, indirect taxes have raised the CPI by 0.75%. We believe that another 0.5% upward effect will emerge in the next few months due to year-end increases in indirect taxes. In addition to those effects, a substantial rise in the CPI can be expected in February and March, due to the close of seasonal sales and hikes in volatile items such as airfare. On the other hand, we see clear signs that the impact of the ISK depreciation during and after the 2008 crash is finally dissipating, and it is clear that domestic price pressures are at a minimum, apart from tax effects. The housing component is likely to decline further in the near future as well. As a result, we consider, as before, that if the króna holds up through the year, inflation will abate quite quickly from Q2 onwards.
Central Bank interest rates: reduction expected in view of new data
  The recent decline in the consumer price index (CPI) increases the chance that the Central Bank will cut interest rates tomorrow. The Monetary Policy Committee (MPC) is meeting today and will announce its decision in the morning. We expect the Committee to decide to lower CBI interest rates marginally; for example, by cutting the current account interest rate from 8.5% to 8.25% and by reducing seven-day collateral lending rates (the policy rate of yore) by half a percentage point to 9.5%. This represents a change from our stance in our pre-CPI forecast, which assumed unchanged interest rates.
In its policy statement from 9 December, the MPC stated that, if the króna holds stable or appreciates, and if inflation subsides in line with forecasts, preconditions for further monetary policy easing should remain in place. Inflation has indeed lost momentum since the last interest rate decision, and the króna has remained rather stable. Thus it appears that two of the MPC's preconditions for further monetary easing are in place.
When the Committee issued its statement in early December, inflation measured 8.6%. Now it stands at 6.6%. In part, the inflation figure is a direct consequence of the rise in indirect taxes, which the MPC will ignore in its decision. If inflation is viewed according to a constant-tax index, it has dropped from 7.7% to 5.2% since the last MPC decision date. In addition, indicators suggest that the negative output gap is growing, that the contraction in GDP is significant, and that unemployment is still on the rise. That being the case, inflation should wane in the near future, and we assume this view will be presented in the Central Bank's new macroeconomic forecast, which will see the light of day tomorrow.
Bond market responds to inflation figures
  The bond market has been lively today, following publication of January CPI figures. Trading volumes have been high, with turnover at ISK 10 bn in Treasury notes and 7.6 bn in HFF bonds as of this writing (2:00 p.m.). T-notes have been subject to buying pressure, while selling pressure has been evident for HFF bonds. This selling pressure is understandable, given that the coming month will see HFF bond principal drop steadily in line with the January decline in the CPI. Yields on HFF bonds have risen by 8-55 bp in today's trading, while Treasury note yields have declined by 10-21 bp during the same session. Three-year breakeven inflation rates in the market have dropped by nearly 0.7%, while the corresponding rate for nine years has dropped by 0.3%. As a result, three-year breakeven inflation rates are now 4.1% and nine-year rates 4%.
Breakeven inflation rates are normalising
 It appears that today's unexpected drop in the CPI may have been the final straw in stopping the virtually uninterrupted decline in HFF yields since the summer of 2009. Before then, investors had shaken off news of a substantially changed outlook for the supply of indexed bonds bearing a Treasury guarantee. Contrary to widely held expectations, the outlook is now for a net surplus of new bonds of this type from the HFF and the Treasury together, while nominal Treasury note issuance net of maturities is likely to be negative. For quite a while, we have posited that breakeven inflation rates in the bond market give an exaggerated view of inflation expectations, but this morning's bond market activity may reduce that error factor significantly.
Consumer sentiment up marginally
  Pessimism among Icelandic consumers subsided slightly between December and January. The Gallup Consumer Sentiment Index, published this morning, rose by 3.1 points month-on-month and now stands at 37.1; however, downbeat sentiment about the economy still predominates, as always when the index is below 100 points.
In spite of overriding pessimism about the economy and labour market, the Consumer Sentiment Index is now considerably higher than it was a year ago, and somewhat above post-crisis averages. In January 2009, for example, it hit an all-time low of 19.5; however, it has averaged about 33 points since the banks collapsed. Clearly, then, Icelandic consumers do not consider the situation quite as bad as it was a year ago, and not as bleak as it has generally been since the banks failed.
Uptick on all subindices
All subindices of the Consumer Sentiment Index rose between December and January, indicating that consumers' attitudes towards the economic and labour situation, both now and six months ahead, are slightly more positive than they were a month ago. The assessment of the current situation rose by just over 2 points to 8.6, and sentiment about the situation six months ahead measured 56.1, up 4 points. Over 78% of respondents consider the economic situation negative at present, and over 54% consider employment possibilities limited. Some 44% of respondents believe the economic situation will be worse in six months' time, and about 31% believe the labour market will be tighter at that point. About 39% of respondents think it likely that their gross income will decline in the next six months.
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OMX ICEX, 1/25/2010
|
| Category |
Volume |
| Bonds |
259,042 |
| Equities |
8 |
|
543,051 |
| Total |
802,101 |
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REIBOR Market, 1/25/2010
|
| Term |
REIBID |
REIBOR |
| O/N |
8.50% |
9.00% |
| SW |
8.50% |
9.00% |
| 1M |
8.75% |
9.00% |
| 3M |
8.00% |
8.40% |
| 6M |
7.30% |
7.80% |
| 12M |
6.75% |
7.00% |
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Exchange Rates, 1/25/2010
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| |
pr.ISK |
3m.Libor |
3m.fwd. |
| USD |
127.45 |
0.25% |
2.6 |
| GBP |
205.73 |
0.62% |
3.9 |
| JPY |
1.42 |
0.25% |
0.0 |
| EUR |
179.50 |
0.61% |
3.4 |
| Vt. ISK |
234.71 |
0.67% |
4.5 |
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Currency Crosses, 1/26/2010
|
| |
EUR |
GBP |
USD |
| GBP |
0.873 |
|
|
| USD |
1.408 |
1.614 |
|
| CHF |
1.472 |
1.687 |
1.045 |
| JPY |
126.293 |
144.748 |
89.671 |
| NOK |
8.248 |
9.454 |
5.857 |
| SEK |
10.272 |
11.773 |
7.293 |
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Icelandic Equities, 1/25/2010 |
| ID |
Vol. |
Yield |
Day.ch. |
| OSSR |
6 |
162.00 |
0.62% |
| FO-EIK |
0 |
83.50 |
1.83% |
| FO-BANK |
0 |
133.50 |
0.00% |
| MARL |
0 |
62.40 |
0.00% |
| NYHR |
0 |
11.00 |
0.00% |
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