Recent developments in pipeline pressures for non-energy industrial goods inflation in the euro area

Prepared by Gerrit Koester, Ieva Rubene, Eduardo Gonçalves and Jakob Nordeman

Published as part of the ECB Economic Bulletin, Issue 5/2021.

Pronounced rises in input costs on a global level have led to marked increases in import and producer prices for intermediate goods in the euro area (Chart A). Surging commodity price inflation, substantial increases in shipping costs and insufficient supply of some raw materials and intermediate products have led to input cost pressures for the euro area.^[1] Such input cost shocks create “pipeline” price pressures at the early stages of the production and distribution chain. Recent developments in input costs have pushed up core producer prices (essentially producer prices in the manufacturing sector), in which intermediate goods have a large weight, with the latter reflecting price increases observed for, especially, basic metals, chemicals and chemical products. How much of these pressures ultimately feeds through to later stages and goods prices at the consumer level depends on many factors, including their duration and firms’ scope and willingness to absorb them by reducing profit margins. In the consumption basket underlying the Harmonised Index of Consumer Prices (HICP) in the euro area, these consumer goods prices are reflected in the category “non-energy industrial goods” (NEIG).

Price pressures have so far been smaller at later stages of the pricing chain than at the earlier stages (Chart B). Domestic producer price inflation for non-food consumer goods – a key measure of pipeline pressures for HICP NEIG inflation – stood at 1.0% in April 2021, up from 0.9% in March and 0.6% in February. While these rates of change and their development appear subdued relative to those for intermediate goods, the latest outcome was well above its long-term average of 0.6% and at a level seen during the late-cycle phase in 2019. At the same time, the annual rate of change in import prices for non-food consumer goods (imports of final goods account for around 12% of the HICP NEIG basket)^[2] remained negative in May, at -0.9%. The magnitude and movement of this rate is closely linked to developments in the euro exchange rate and continues to be affected by the appreciation of the euro compared with its level a year ago.

Looking ahead, upward pressures from recent input cost developments may still affect NEIG inflation, as the pass-through to consumer prices usually takes more than one year. As production takes time, there are often substantial lags in the speed at which cost pressures affect different stages of the pricing chain. Additional factors that can prolong the pass-through to prices include long-term pricing contracts, a high proportion of fixed prices and (especially larger) firms seeking to stabilise their input costs through hedging. Correlation analysis indicates that it takes around one year for changes in intermediate goods prices to pass through to NEIG inflation.^[3] A simple reduced-form regression analysis, which also takes demand considerations into account, finds a somewhat longer time lag: around half a year for changes in intermediate goods prices to pass through to producer prices for non-food consumer goods (with a relatively low pass-through of around one-quarter) followed by at least another year and a half for the complete pass-through (close to one) of these pressures to NEIG inflation (Chart C).^[4]

However, the pass-through is not automatic and is also likely to vary over time. At each stage pricing decisions depend upon a range of other factors (including capacity utilisation, the stock of inventories, profit absorption and the competitive environment). It could well be, therefore, that a visible cost-push shock emerging at the early stage is absorbed along the various subsequent production and retail stages and no longer appears at the stage of final consumer prices. Using the time profile of the impact shown in Chart C, the cumulative upward pressures on NEIG resulting from producer price developments for non-food consumer goods over the last few years appear essentially to reflect the producer price developments up to 2019; thereafter, they have been partially offset by other factors (Chart D). The impact of the upward movements in producer price inflation in recent months is then yet to come. However, assessing this pass-through may be complicated by the recent strong volatility in NEIG inflation due to changes in sale periods in the summer of 2020 and first quarter of 2021. More generally, the unique situation related to the coronavirus (COVID-19) pandemic could imply some deviation from normal pass-through patterns, and does not exclude the possibility of a stronger than usual pass-through from rising input costs to consumer prices if, for instance, firms’ margins are squeezed and consumers may have some pent-up demand and unexpected savings to finance it.^[5]

Overall, even somewhat stronger developments in NEIG inflation would not lead to a substantial strengthening of underlying inflation developments in the euro area. NEIG inflation has tended to be relatively subdued in the euro area, averaging 0.6% from 1999 to 2019, compared with average HICP inflation excluding energy and food of 1.4% over the same period.^[6] While the pandemic has temporarily reduced the consumption of services relative to goods somewhat, underlying inflation dynamics continue to be predominantly driven by services inflation (with a weight of around two-thirds in the HICP excluding energy and food), for which wages, and not intermediate products or raw materials, represent the lion’s share of input costs.