"Adverse effects for Icelandic families"
Iceland is currently grappling with a surge in inflation, with various sectors of the economy feeling the impact. The latest data shows a 0.84% increase in monthly inflation, a significant rise compared to the 0.48% increase during the same period last year. This has led to a 75% increase in inflation compared to last year.
One of the major drivers of inflation in Iceland is the housing market. Inflation has been heavily influenced by house prices, which surged about 50% between mid-2020 and early 2023. Housing costs alone account for over half of consumer price inflation, making the economy very sensitive to changes in this sector.
Iceland's economy, which is relatively small and concentrated, is vulnerable to external shocks and domestic overheating. This vulnerability can amplify the effects of inflationary pressures on financial stability. Additionally, Iceland's energy sector faces pressures from rising demand and aging infrastructure, contributing indirectly to inflationary pressures by affecting production costs and energy prices.
To curb inflation, several measures are being suggested and implemented. The Central Bank of Iceland is maintaining a tight monetary stance to rein in inflation and manage inflation expectations until they settle around the target of 2.5%. Gradually increasing fiscal buffers and ensuring prudent fiscal management are emphasized to support economic resilience and control inflationary pressures.
Structural reforms are seen as key to reducing vulnerability. This includes modernizing policies to improve productivity and economic diversification, such as easing product market regulations, improving the business climate by cutting red tape, opening for more foreign investment, and streamlining insolvency rules.
Given the outsized role of housing in inflation, policies targeting housing supply and demand imbalances are implied to help stabilize prices. Fast-tracking approval for energy projects can help alleviate energy cost pressures and support the economy's green ambitions, indirectly helping with inflation control.
Vilhjálmur Birgisson, chairman of the Icelandic Federation of General and Special Workers, has expressed concern about the recent spike in inflation. Birgisson suggests that abolishing indexation is the first and most urgent step to address inflation in Iceland. Indexation, which is a common practice in Iceland, increases the cost of loans and rents based on inflation, and Birgisson claims that most Icelanders choose indexed loans due to unaffordable monthly payments for non-indexed loans, mainly due to high interest rates.
Birgisson argues that everyone, not just workers, must contribute to controlling inflation in Iceland. He expresses concern that accepting high inflation rates, such as a 13% increase in airfares, normalizes the situation. Birgisson also suggests that if indexation didn't exist, interest rates in Iceland would likely be lower.
In the hospitality sector, hotel and restaurant prices have increased by 2.3% this month, and airfares have risen by 12.7%. Tourism and related sectors are driving inflation in Iceland. Birgisson argues that all market actors, including airline companies, must take responsibility for inflation in Iceland.
Iceland is aiming to balance bringing inflation back to target levels with ensuring a "soft landing" for the economy, relying on coordinated fiscal, monetary, and structural policies to mitigate the impact of inflation surges. The integrated approach reflects Iceland's economic characteristics and the complex challenges it faces in controlling inflation while maintaining growth and stability.
Despite the surge in inflation, the tourism sector, specifically airfares and hospitality services, is contributing significantly to the overall inflation rate in Iceland. In light of this, it is crucial for airline companies and other tourism-related businesses to review their pricing strategies to help curb inflation.
The ongoing inflation has also raised concerns about the financial sector, with indexation being a main area of focus. According to Vilhjálmur Birgisson, chairman of the Icelandic Federation of General and Special Workers, abolishing indexation could be a crucial step in addressing inflation, as it significantly impacts the cost of loans and rents in Iceland.
