MONETARY POLICY REPORT | SUMMER 2021 (box 1)
(authors: Soňa Benecká, Jan Brůha, Jan Šolc)
The surge in industrial producer price inflation seen both at home and abroad is a result of three factors. The first is strong demand for industrial (intermediate) goods and the recovery in this sector in 2020 H2 caused by demand switching partially from services to goods due to the pandemic. Related to this is the second factor driving prices upward: persisting problems in global production and supply chains. The final piece of the price pressure puzzle stems from a sharp rise in commodity prices,[1] which partly reflects recovering demand. Some of these price pressures are temporary and can be expected to correct after the current shortages and problems in production chains abate. However, part of the recent increase in inflation pressures is grounded in fundamentals and will affect prices for some time to come.
This box analyses prices in manufacturing both abroad and at home and assesses to what extent they are being driven by non-fundamental (i.e. temporary) or fundamental factors.
Evaluating the ratio of temporary to fundamental price pressures is crucial for configuring monetary policy appropriately. If the price growth was being driven mostly by temporary effects, the current inflation pressures would be only a transitory, short-term episode, one which monetary policy would not need to respond to significantly. By contrast, a timely monetary policy response is desirable in the event of substantial fundamental inflation pressures.
The temporary price pressures in producer prices reflect supply chain disruptions and shortages of materials and components. According to a European Commission survey, the latter are at record highs and have been spilling over into firms’ expectations regarding the selling prices of their products in recent months. Supply issues have been reported by a whole range of industries, most notably chemicals and petrochemicals. Firms are also being affected by disruptions to supplies of plastics, computer chips and wood. Generally, the sectors reporting the biggest supply issues also have the highest share of firms expecting prices to rise (see Chart 1). This share is over 50% for firms in the hardest-hit industries (wood, paper and metals). However, it is only 20% for companies in the motor vehicles sector, despite major problems with supplies of inputs. The price effect of overloaded supply chains thus seems to depend also on the sector’s position in the production vertical. According to CNB analyses, the price pressure will fade relatively quickly once the problems with equipment supplies disappear.[2] Firms’ expectations regarding growth in their own selling prices affect actual industrial producer price inflation (PPI) for some time (see Chart 2). However, the trends are again very mixed across sectors. The pass-through of price expectations to prices in industry is stronger and faster in sectors where commodities have a dominant effect, while it is shifted (lagged) by three months in the motor vehicles sector compared to other industries. The effect will peak after six months and then gradually fade out in both the euro area and the Czech Republic.
Chart 1 – Firms’ selling price expectations are highest in sectors facing input availability problems
%; European Commission euro area survey; data for 2021 Q2
Chart 2 – Firms’ expectations about growth in their selling prices are reflected most strongly in actual industrial producer prices six months ahead
x-axis: lag in months; y-axis: correlation coefficient between change in expected growth in selling prices in three months and annual industrial producer price inflation
We construct a statistical filter to break down the growth in producer prices in individual manufacturing industries into long-term and temporary factors. Besides producer price inflation, the filter uses data on industrial production and selected commodity prices. It also allows us to identify very positive shocks with low persistence, which we interpret as a temporary, quickly subsiding non-fundamental factor. The effect of commodities identified by the filter is also assessed as temporary. After adjusting for residuals and the effect of commodities, we obtain a synthetic producer price series containing a trend component and a cyclical component. Unlike the previous short-term factors, they are long-term in nature and there is no risk of them correcting suddenly. Given the aforementioned diverse nature of manufacturing industries, we apply the filter to each industry separately and then aggregate the effect on the overall manufacturing PPI from the individual components.
Adjusted for factors that might subside quickly, the synthetic level of PPI prices in the euro area is only 1.4% lower than the actual figure (see Chart 3). As a result, any price correction should not be extremely strong. We should emphasise that this is an upper estimate of the possible effect, as commodity prices themselves are affected by global industrial production, so the demand for commodities and the growth in their prices at least partly reflect cyclical factors as well. A similar conclusion applies for the Czech data. Again, the difference between the actual figure and the adjusted series is currently around 1.4% (see Chart 4). So, a marked correction cannot be expected in this case either. This result for both territories can also be explained by the lag with which material and equipment shortages pass through to prices. For the near future, the current overloading of production and supply chains is an inflationary factor (as the effect on producer prices is yet to peak) rather than constituting an anti-inflationary risk of a rapid producer price correction.
Chart 3 – Adjusted for temporary factors, industrial producer prices in the euro area would be only slightly lower
index; 1/15 = 100
Chart 4 – A similarly small difference between the actual and adjusted PPI series as in the euro area can be identified for the Czech Republic
index; 1/15 = 100
Note: The filter uses machine-learning methods which – unlike the usual Kalman filter – allow us to assume that these shocks are only temporary, i.e. there have been few of them in history. The filter identifies episodes where these shocks affect the producer price time series. In addition to the present year, which is the focus of the analysis, these shocks are identified for the euro area in 2018 and the Czech Republic in 2019. These were periods when some sectors also reported shortages of materials.
The pass-through of the temporary factors identified above to consumer prices is not dramatic. The industries in which we identify price growth above and beyond fundamental factors affect the retail prices of around 60 consumer basket items. Their total weight is around 15% of the consumer basket, and the vast majority of them are core inflation items. To identify those items, we used Eurostat’s correspondence tables, which make it possible to link various statistical classifications.[3] They can be used to identify which consumer basket items are affected by production in a given (in our case industrial) sector. Given the elasticity between consumer prices of tradable commodities and the manufacturing PPI, the effect of an increase in producer prices caused by temporary factors on consumer prices can be estimated at around 0.14 pp.
To sum up, the price growth observed in most manufacturing industries in the euro area and the Czech Republic is consistent with recovering demand and output and is largely fundamental in nature. However, some sectors are experiencing high growth in commodity prices and issues in production chains. These short-term effects may fade quickly, and the currently strong price growth in these sectors is thus partly temporary. This effect can also be observed in the manufacturing price index as a whole, but it is not dramatic. The analysis also shows that if the problems with overloaded production chains and commodity prices persist, we can expect additional price growth in the industries concerned and, in turn, an increase in the retail prices of the relevant consumer basket items. It would thus be premature to discount to any great extent the current inflation pressures from the production sector for monetary policy and to expect producer prices to decline rapidly and domestic core inflation to slow soon as a result. The conclusions of the analysis are thus part of the CNB’s summer forecast. It expects buoyant growth in producer prices both at home and abroad for the rest of the year, followed by a gradual decline to close to steady-state growth. The decline in domestic core inflation, which has recently been the largest driver of consumer price inflation, will therefore be only gradual.
[1] The pressures stemming from commodity price growth and overloaded production chains were discussed in a box in MPR – Spring 2021.
[2] The effect of problems with equipment supplies on firms’ price expectations will be discussed in detail in the Focus section of the August issue of Global Economic Outlook.
[3] For details, see, for example, http://ec.europa.eu/eurostat/ramon/documents/COICOP_2018-CPA_2_1/COICOP_2018-CPA_2_1.zip