The transmission of external cost shocks into domestic prices in 2003–2005

The history of the current external cost shock is associated with year-on-year growth in prices of energy-producing materials and metals on world markets, which emerged in mid-2002 and, with some fluctuations, gradually accelerated to high figures in 2004. World commodity prices are, via import prices, an important inflation factor in the Czech Republic, owing to the high openness of the Czech economy and the high import intensity of GDP.

Chart 1
The high growth in world commodity prices was significantly offset by year-on-year appreciation of the koruna-dollar exchange rate
(annual percentage changes)

However, the contribution of rising oil, gas and metal price growth to the upturn in import price inflation was less intense, since it was significantly dampened by year-on-year appreciation of the koruna-dollar exchange rate (Chart 1). As a result, the year-on-year rise in prices of imported inputs was not high in 2003, and a more pronounced acceleration was recorded only during 2004 due to a more marked pick-up in prices of these commodities on world markets. The annual growth in prices of imported energy-producing and non-energy-producing materials reached quite high levels in 2004 and was a key factor underlying the pick-up in total import price inflation (Chart 2). At the start of 2005, total import growth decreased year on year, but commodities prices continued rising.

Chart 2
High growth in import prices of energy-producing materials and metals was the key factor of the total import price growth
(annual percentage changes; contributions in percentage points)

Greater impacts of the increasing prices of external inputs on producer prices were apparent in 2004. The high prices of imported energy-producing materials and metals most strongly affected industrial producer prices (PPI) and prices of materials and products consumed in the construction industry. Within industry, their effect was most pronounced in branches involved in primary oil and metal processing. Chart 3 shows that price increases in these manufacturing branches were the main reason for the high PPI growth in 2004, which fluctuated above 7% in the second half of the year.

The evolution of producer prices at the individual stages of the product vertical in oil-based branches indicated that the transmission of the increased prices of external cost inputs was very fast. Its gradual slowdown at subsequent stages of the product vertical towards products with a higher degree of processing can be explained by a falling proportion of oil intermediate products in the total product. The high annual growth in producer prices in branches involved in primary oil product processing - manufacture of coke and refined petroleum products - was almost the same as that of oil prices on world markets and fully covered the rise in prices of imported inputs, since profit margins in this industry rose year on year. In the chemical industry, prices rose more slowly. The relatively low inflation in the branches of this industry which lie at the end of the product vertical, whose output includes final products, was probably also affected by the strongly competitive environment on the consumer market.

Chart 3
Fast-rising prices of external inputs were the main cause of the high industrial producer price inflation
(annual percentage changes; contributions in percentage points)

In branches whose production depends heavily on metal inputs, annual producer price inflation also decreased in the product vertical towards products with a higher degree of processing. Compared with oil-based industries, however, the transmission process was rather slower and the producer prices of some products with a high degree of processing even showed annual decreases. The slower transmission in metal-based branches was due to different needs for basic material inputs, the length of technological processing and, in some branches, the demand situation.

Chart 4
The intensity of transmission of the high oil prices into product prices in the product vertical gradually decreased
(annual percentage changes)

The high price growth in primary industries reflected the robust demand for these products. By contrast, falling year-on-year prices of transport equipment and some other products with a high degree of processing suggested that both the Czech market and the markets of other European countries are currently saturated with such products. In the manufacture of machinery and equipment, a pick-up in investment demand allowed the increased input costs to be reflected in prices.

The evolution of producer prices in 2004 shows that the transmission of large external cost shocks is quite quick. The speed and intensity of transmission, however, is also dependent on other factors, in particular the koruna's exchange rate, the type of products produced (share of input material, length of technological processing), the level of demand, and competition on the market. In 2004, the impact of external cost pressures was also softened by increasing productivity and subdued wage growth. Producer prices at the last stages of the product vertical were furthermore affected by conditions on the consumer market, in particular increasing foreign competition.

Chart 5
The intensity of transmission of the high metals prices in the product vertical also gradually diminished
(annual percentage changes)