Chapter 13 of 13

Appendix: The Seðlabanki's own evidence

A reader familiar with the Central Bank of Iceland's public communications in 2025 and 2026 will notice that the reading offered in this piece is not the one the bank itself has been giving. The CBI's narrative — repeated across Peningamál 2026/1, Fjármálastöðugleiki 2026/1, MPC statements, and Working Paper #100 — is that stubborn inflation is the product of a damaged anchor of inflation expectations ("löskuð kjölfesta verðbólguvæntinga") combined with lingering wage-push and service-sector indexation. In this telling, the right policy is for the central bank to demonstrate firmness until expectations re-anchor, at which point inflation will follow.

It is worth being explicit about the relationship between that narrative and the reading in this piece, because the central bank's own publications contain most of the pieces of the housing-driven story — they just stop short of connecting them.

What the CBI says it thinks. In the governor's summary of Peningamál 2026/1 (4 February 2026), the Monetary Policy Committee held the policy rate at 7.25% (it then hiked three times in 2026 — 7.50% on 18 March, 7.75% on 20 May, 8.00% on 19 August) and wrote: "Svo virðist sem löskuð kjölfesta verðbólguvæntinga og kostnaðarhækkanir á undanförnum misserum hafi leitt til þess að verðbólga hefur verið þrálátari en ella" — roughly, "it appears that a damaged anchor of inflation expectations and cost increases in recent periods have led to inflation being more stubborn than it would otherwise have been." Fjármálastöðugleiki 2026/1 makes the same claim and adds an amplifier: "útbreidd verðtrygging þjónustusamninga og skortur á kjölfestu verðbólguvæntinga" — widespread indexation of service contracts together with lack of anchored expectations. Those two sentences, repeated near-verbatim across the bank's main publications, are the public thesis.

What the CBI's own Financial Stability Report says about the 2021–2022 housing price surge. In the same edition of FSR 2026/1, in the section on the housing market, the bank writes: "Hækkun íbúðaverðs árin 2021 og 2022 var að miklu leyti drifin áfram af lækkun vaxta og aðflutningi fólks, samhliða vexti í vinnuaflsfrekum atvinnugreinum" — "the rise in housing prices in 2021 and 2022 was largely driven by rate cuts, the inflow of people, and the growth of labor-intensive industries." That is the causal chain in this piece, stated in the central bank's own publication. Rate cuts plus migration plus labor-intensive sector growth. The FSR goes on to note that foreign citizens in Iceland are disproportionately renters, that slower migration would reduce housing demand, and that the rental market is sensitive to migration flows. The demand-side demographic mechanism is acknowledged.

What the governor said in Parliament on 21 October 2025. In testimony to the Alþingi's Committee on Economic Affairs and Commerce, Governor Ásgeir Jónsson said plainly: "Það er ákveðinn þröskuldur í kringum 4 prósentin... Verðbólga án húsnæðisliðar er um 2,5% en um 4% þegar húsnæðisliðurinn er tekinn með." — "There is a certain threshold around 4 percent... Inflation excluding the housing component is about 2.5%; it is about 4% when the housing component is included." That is the governor, in public testimony, saying that the entire gap between realized and target inflation is the housing component. He also cited the Grindavík eruption displacements as a shock to housing demand. That testimony is not cited in the subsequent Peningamál or the FSR.

What the FSR sees about the rate tool and housing supply. The FSR 2026/1 devotes several pages to the construction sector under rate pressure: over half of new builds are now selling below asking price, new-build inventory time in the capital area has reached roughly 18 months, Stage-2 ("higher-risk") construction loans are growing rapidly, and bank exposure to the sector has risen from about 11% of corporate loans in mid-2021 to roughly 19% by early 2026. The report describes these as elevated financial stability risks emerging from rate policy biting on the supply side. It does not describe them as evidence that the rate tool is asymmetric — that it cuts housing supply faster than it cuts housing demand — but that is what the pattern is.

What the FSR sees about household resilience and the verðtryggð refinancing. FSR 2026/1 reports that the indexed (verðtryggð) share of outstanding mortgages rose by more than 4 percentage points year-on-year to 65% by January 2026, while household debt-to-income ratios fell across every income decile and real wages rose 2.5% year-on-year. The bank interprets this as household resilience. The alternative reading — that households used indexation refinancing to escape the payment-shock channel the rate tool was supposed to work through, leaving consumption and rental bidding intact — is the other side of the same data. The FSR does not entertain it.

What the deputy governor said at the HMS autumn meeting, 27 August 2026. Tómas Brynjólfsson, deputy governor for financial stability, devoted his annual housing-market presentation to a set of admissions that go considerably further than any earlier CBI communication. Supply, he said, is now abundant after years of heavy construction — "mikið framboð" — with clear signs that construction activity is slowing. The long inventory time of new builds is a stated concern: "mikið framboð og langur birgðatími nýbygginga sé áhyggjuefni." And he put the causal weight on the population shock this piece has been describing: strong population growth "had a significant part in the rise in house prices in recent years," with the Grindavík unrest adding a discrete 2024 impulse. The same slide deck documents the borrower-conditions loosening of 31 October 2025 — first-time-buyer LTV raised from 85% to 90%, DSTI exemption headroom from 5% to 10% of quarterly originations — and argues that the conditions held back a debt bubble. Taken as a whole, the speech is the CBI's financial-stability arm describing the housing market in terms the institution had previously reserved for its forecasts: a demand shock from migration, an oversupplied construction sector, and a long clearance horizon. The slide deck goes further than the summary article in one respect worth naming. Slide 7 makes an explicit cost claim: borrower-based measures achieve the goal of housing-market stability "at lower macroeconomic cost than with interest rates alone" ("Minni þjóðhagslegur kostnaður við að ná markmiði um stöðugleika á húsnæðismarkaði en með vöxtum einum saman"). That is the bank's financial-stability arm conceding, in its own material, that the rate instrument is the expensive way to stabilize housing — the asymmetry this piece argues for, stated by the institution itself. The same deck reports the post-loosening empirics: the higher first-time-buyer LTV is being used, but the DSTI exemption headroom is used less, fewer low-income first-time buyers now carry high payment-burden ratios, and first-time buyers are still entering the market — the bank's own evidence that the October 2025 loosening did not reignite risk. And slide 17 marks the pivot this piece has been tracking: "after the risk of a house-price bubble, there are now indications of oversupply" ("Eftir hættu á verðbóluverðbólu eru vísbendingar um offramboð"). It still frames the borrower rules as the stabilizer and does not connect the dots to the rate tool's asymmetric bite — but the housing-market description is now the one in this piece.

What Monetary Bulletin 2026/3 adds (19 August 2026). The CBI's August inflation forecast now shows headline inflation running 5.6% in Q3 and 5.7% in Q4 2026, with a return to target only in H1/2028 — and explicitly attributes part of the recent easing to the housing channel cooling through migration: "slower growth in the imported labour force has cut into demand for rentals," while "year-on-year population growth has retreated to its pandemic-era level." The bulletin also reports new-build inventory time at 15 months and notes that sellers of new builds have not lowered asking prices significantly despite the stock. The bank's own forecast thus embeds the demographic-demand channel this piece identifies — and still concludes that the right response is to hold rates at 8.00% until expectations re-anchor.

What this means. Taken together, the CBI's own publications contain: (a) the causal chain from rate cuts and labor migration to 2021–2022 housing price pressure, (b) the rental-market exposure of foreign citizens, (c) the rate tool biting hardest on the construction supply response, (d) the household indexation refinancing that insulated consumption from the rate channel, and (e) the governor's public testimony that the entire inflation gap is a housing gap. The reading offered in this piece assembles these into a single causal chain: demographic demand shock into a constrained housing stock, with rate policy asymmetrically cutting supply, and indexed contracts mechanically propagating shelter inflation into the rest of the CPI basket. The CBI's official narrative — the "löskuð kjölfesta" thesis — treats the same set of facts as structural amplifiers on top of a fundamentally expectational problem, and directs policy toward firmness of the rate instrument.

The honest summary is this: the Seðlabanki has the evidence for the housing-driven reading in its own publications. It just does not draw the line between the dots. Neither does the official narrative in Working Paper #100, which, using a Bayesian trend-cycle decomposition (UCSV-AR), labels a persistent low-frequency component of realized inflation as "damaged expectations anchor." That label is a choice, not a finding: the same trend is observationally equivalent to unresolved cost pass-through from a real-resource bottleneck, and the bank's econometric work does not — and cannot — distinguish between the two interpretations.

Where this piece and the CBI agree: service-contract indexation is a structural amplifier, construction under rate pressure is in real distress, and the migration-plus-labor-intensive-growth pattern of 2021–2022 was the driver of the housing surge. Where they disagree: whether the subsequent 2023–2026 stubbornness is an expectations problem the rate tool can eventually fix, or a real-resource problem that fiscal and planning policy has to fix and the rate tool is making worse. The disagreement matters because it changes what Iceland is supposed to do next. If it is an expectations problem, more firmness on rates is the prescription. If it is a real-resource problem, rates should come down and the building should start.

The data in this piece suggests it is a real-resource problem. The Seðlabanki's own publications contain most of the evidence for that reading. And on 27 August 2026, the bank's deputy governor for financial stability said most of it out loud — abundant supply, slowing construction, population growth as the driver of the price surge, long new-build inventory as a concern. What the bank still will not say is what follows from its own description: that the policy rate is the wrong instrument for the real-resource gap it has just documented, and that continuing to raise it — to 8.00% in August 2026 — makes the construction distress and the inventory overhang worse while doing nothing for the rental scarcity that remains. The gap between the bank's housing-market analysis and its monetary prescription is now the largest in its public record.