Global Daily – Supply bottlenecks and eurozone inflation

by: Nick Kounis

Euro Macro: Upward pressures on consumer prices from bottlenecks likely moderate – Eurozone producer prices continued their surge in April, accelerating to 7.6% yoy from 4.3% in March. What explains the rise in producer prices? …and how much upward pressure will result for consumer price inflation?

More than half of the current rate of producer price inflation can be explained by surging energy prices, which are running at 20.4% yoy. Having said that, even excluding energy prices, producer prices accelerated to 3.5% yoy in April from 2.3%. In addition, inflation has been accelerating across the major industrial categories (consumer durable, non-durables and capital goods).

The more general price pressures we are seeing partly reflect rises in commodity prices (including energy), which feed through into the prices of other manufactured goods. In addition, there are bottlenecks in terms of supply of some intermediate goods, pushing up their prices, as well as in transportation. This is especially the case in shipping, where freight rates have increased significantly.

The relationship between producer prices and consumer prices is not straightforward. The part of the consumer price basket that is most impacted by shifts in producer prices is the core goods price index (known officially as industrial goods excluding energy). Below we show a chart of the relationship between producer price inflation excluding energy and core goods price inflation.

As can be seen in the chart, while there is some relationship between the two series, it is not very strong, as it is inconsistent in the sense that sometimes consumer prices follow producer prices higher and sometimes they do not. In addition, there are long and variable lags between producer and consumer prices. This might be because companies are various points in the chain sometimes absorb higher input costs in margins, while sometimes they pass them on into prices. The balance between demand and supply capacity is likely is the key factor in determining whether higher input costs are passed on or not.

In terms of the current situation, it is difficult to judge how much core goods price inflation has been influenced by developments in producer prices. This is because consumer prices have been extremely volatile because of a number of specific features of the pandemic. It is however likely that the rise in producer prices will also have some upward pressure on consumer prices because of the combination of recovering demand and supply bottlenecks.

This leads to the questions of how much upward pressure and how long it will last. The upward pressure will likely be moderate because core consumer prices are not dominant in the consumer price index, at around 27% of the overall consumer price index, and just below 40% of the core index. Core producer price inflation could rise further to around 5% yoy according to a number of indicators we follow. Even if there is full pass through to the consumer level (which is a big if), core goods inflation would likely rise to around 1.5% yoy from 0.7% currently. That would boost overall inflation by 0.2% over the coming months, and core inflation by 0.3%.

These price pressure are likely to dissipate over the coming months. Supply bottlenecks should ease. In addition, as economies re-open, we could see consumer demand shift back towards services and away from manufactured goods. Finally, commodity price inflation should fall back on the basis of our forecasts. The outlook for inflation over the medium term will remain more tied to more fundamental inflationary pressures emanating from the labour market. Given the level of slack in the labour market, we still judge that the medium term inflation outlook remains subdued.