The first signs of improvement can be seen in inflation. The inflation rate in the euro area has indeed fallen somewhat in recent months. It was 10.6 percent in October last year, and 7.0 percent in April.
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However, in order to prevent any discussions that interest rate hikes could already be over, the European Central Bank (ECB) is currently happy to point out that the so-called core rate of inflation is still very high.
ECB President Christine Lagarde recently said of the rate hike: "Headline inflation has moderated in recent months, but underlying price pressures remain strong." And ECB Executive Board member Isabel Schnabel said on Tuesday evening that the ECB should not rest "until it becomes apparent that core inflation will also decline sustainably".
The trend part of inflation
This deserves a closer look. What is core inflation, why does it play an important role right now, and why is it different from that of the inflation rate as a whole?
The US economist Robert J. Gordon is considered the "father of core inflation" in the 1970s. The rate comes in variants, but the best known shows inflation without the prices of energy and food. It is supposed to represent the core of inflation, beyond all more or less random short-term fluctuations, the "heart", so to speak.
Annette Fröhling, price expert at the Deutsche Bundesbank in Frankfurt, says that the concept is "an attempt to work out the trend of inflation more strongly than short-term fluctuations".
It is important for the central bank to capture this trend so that it can react appropriately with interest rate policy. Even though the ECB's inflation target of 2 percent explicitly refers to the headline inflation rate and not to the core rate. However, the ECB now describes it as part of its "reaction function" towards this goal that it takes into account the "dynamics of underlying inflation": this means core inflation, plus a few other measures.
What you do when you calculate core inflation rather than headline inflation is a form of smoothing and, to some extent, a focus on variables that can be more influenced by the central bank. The prices for energy, which often fluctuate in the short term and are formed on the world markets outside the central bank's sphere of influence, and the prices for food, which fluctuate with the season in agriculture, but also with commodity prices, are excluded. None of this is perfect, but it does seem to offer some evidence of a somewhat longer-term trend in inflation here.
Core inflation in the euro area is currently 5.6 percent, in Germany it is 5.8 percent according to the national calculation method of the consumer price index (CPI), and 5.6 percent according to the European harmonized index of consumer prices (HICP). The first and last of these three values fell slightly in April compared to March, while the middle one stagnated. In any case, this is far more than the long-term average of around 1.3 percent.
Services and industrial goods at the centre
If you want to understand why core inflation is not declining as much as the inflation rate as a whole, you have to look at what prices play a strong role in it. Since energy and food are excluded from the core rate, it is mainly industrial goods and services that remain.
Among them, there are again individual prizes with a particularly high share. In Germany (HICP), for example, these are rents at 7 percent. "Other major items include prices in restaurants, clothing, package tours and motor vehicles," says price expert Fröhling. In the case of these large components of the rate, prices have risen sharply almost everywhere over the year, with the exception of rents: "The increase was recently 2 percent."
The stubbornly high core inflation is therefore to be found in industrial goods and services. In the case of industrial goods, it was effects related to the pandemic that had caused high prices for a long time, such as supply bottlenecks. However, this effect has weakened. In addition, the role of corporate profits is discussed. High energy prices have also made industrial goods more expensive, which would also have to decrease over time.
Inflation for industrial goods by around 7 percent
"In the case of industrial goods, inflation has now reached a plateau of around 7 percent," says price expert Fröhling.
The services are particularly exciting. They account for about two-thirds of the core inflation rate, while manufactured goods account for only one-third. In the case of services, however, labour plays a particularly important role in overall costs – one could therefore see here when high wage settlements as a result of inflation in turn begin to drive inflation.
So far, however, we have not seen much of this in the figures for the development of the prices of individual services in the consumer price statistics; But maybe it's just too early.
In addition, there could be opposing effects: If, for example, the post-Corona rush to restaurants subsides, it could become more difficult for restaurant owners to enforce higher prices over time. In addition, energy costs for restaurant owners will also fall somewhat over time, which could reduce the pressure for price increases.
"In the case of services, the price increase over the year is currently just under 5 percent," says price expert Fröhling. "Lower energy prices and diminishing Corona catch-up effects are likely to have a relieving effect here."