The impact of the still fast growing world prices of energy-producing materials on inflation in the Czech Republic

The strong upswing in prices of energy-producing materials on world prices, observed since September 2007, has significantly affected inflation in the Czech Republic. This box focuses on defining the impact of this cost shock on consumer prices in the Czech Republic, in particular in terms of its magnitude and the speed of pass-through to final prices on the consumer market.

The definition is based on the classification of energy prices in the consumer basket. The energy category in the consumer basket comprises prices of electricity, gas, heat, liquid and solid fuels, and vehicle fuels. Their weight in this basket is around 13%. The overall impact of energy prices on inflation is also determined by the rates of growth of their individual items, which are often substantially different from the other consumer basket items. As Chart 1 (Box) shows, the contribution of the prices of these energy components to the annual increase in consumer prices exceeded one percentage point in the period of highest growth of world prices of energy-producing materials at the start of 2008. But energy prices are not contained solely in the above consumer price items; they indirectly affect inflation in other categories of goods and services. However, quantifying the impact of rising energy prices on consumer prices is more difficult in these cases.

Prices of energy for households are mostly regulated; the share of energy with entirely free pricing is lower. But it should be mentioned in this connection that prices of electricity, heat and gas are currently regulated only partially: the energy price itself is determined by market conditions, and only the services component, associated with the supply (distribution) of energy to consumers, is still subject to regulation.

Of the above energy items, changes in world prices of energy-producing materials pass through most quickly to consumer prices of vehicle fuels. Oil price movements adjusted by the koruna-dollar exchange rate are reflected in consumer prices of fuels with a lag of up to two months. However, consumer prices of fuels do not respond to oil price movements to the full extent, as part of their price is determined by a fixed excise duty rate per litre and only the remaining part is affected by changes in koruna oil prices. Different excise duty rates are set for different types of fuels (about 39% for petrol and around 33% for diesel at their current prices), which implies different impacts on their consumer prices.

Prices of natural gas on world markets follow changes in oil prices with a lag of roughly two or three quarters. This relatively close linkage is due not only to the substitutability of oil and gas as energy-producing materials, but also to the fact that contracts for natural gas are derived from past oil prices. Natural gas prices for households respond to changes in world prices of natural gas with a lag of roughly one quarter. Moreover, changes to regulated prices of natural gas are always made at the start of the quarter, which may prolong the transmission of foreign prices to domestic prices in the case of major fluctuations in world gas prices. The dependence of electricity prices on oil prices is less pronounced than in the case of natural gas, since electricity can be generated to a larger extent on the European market using other sources (nuclear power plants, etc.). The composition of energy-producing materials varies from one European country to the next, and this is reflected in the costs of electricity generation. Consumer prices of electricity, whose “market” component is derived from electricity prices on the European market, is thus not primarily determined by prices of oil and oil products on world markets. However, a correlation between consumer prices of coal and electricity for the domestic market is observed for two reasons: coal is an important energy source used in electricity generation and, at the same time, a substitute source of heat for households. For these reasons, regulated prices of electricity are changed at longer time intervals (typically annually) than natural gas prices, as shown in Chart 1 (Box).

In the other consumer basket categories, a pronounced effect of the fast growing energy prices has been observed for non-tradable commodities (mostly services), where the options for offsetting rising costs by increasing productivity are limited. Despite this, the pass-through of changes in energy prices to this segment of consumer prices is far more gradual than for the above-mentioned energy components, as service providers face stiffer market competition than corporations in power generation, and, moreover, the weight of energy in prices of services is lower.

In order to quantify the effect of energy prices on consumer price inflation, a simulation has been carried out using the CNB’s modelling system. The simulation assumes an increase in oil prices of USD 25 a barrel for the next two years compared to the current outlook used in the CNB forecast (see Table III.1). The effect of this increase in dollar prices of oil on the corresponding foreign variables used in the CNB’s modelling system (towards higher inflation and interest rates amid broadly unchanged demand) was computed by means of a NIGEM model simulation. The higher oil prices have an upward effect on domestic regulated prices also via higher natural gas prices. The impact on annual growth in consumer prices is the highest in the course of the first year of the shock, amounting to 0.4 percentage point. It is reflected in both regulated and market prices, although the transmission channel through regulated prices is markedly stronger. The scenario of a decline in oil prices would lead to the same conclusions, but with the opposite sign.

Table 1 (Box) Weights of energy in the consumer basket

Energy prices are mostly regulated
(per mil)