The escalation of underlying inflation: a phenomenon that comes from afar

Core inflation shows the true inflationary pressures of an economy when taking into account the growth of all the goods and services that citizens consume, with the exception of the prices of unprocessed food and energy products.

In the Spanish case, the advance data of the CPI for the month of February 2023 shows a very worrying evolution of inflation. It is true that the maximum level was reached in July 2022, with a growth of the general CPI index of 10.8%, but it is no less evident that core inflation has not stopped growing, reaching its maximum in February with the 7.7% and outpacing headline inflation, which is now at 6.1%, for the third consecutive month.

It seems a paradox that, if a large part of the inflationary pressures in the Spanish economy in 2022 were due to the behavior of these headings, the best data for these months, in which inflation has moderated its growth, are also due to the containment in the prices of unprocessed food and energy products. It must also be recognized that they have a Delayed effect which is manifested in the growth, sustained over time, of the hard core of inflation: underlying inflation.

runaway rubrics

Perhaps we have paid little attention to an obvious fact. Consumers, when we consume, we do so above all of manufactured goods, which have some kind of transformation.

Energy not only makes transportation more expensive for consumers and heating their homes: it also affects the production costs of the companies that produce these goods, and their distribution. And that’s where you see this Delayed effect of energy prices that, like a shock wave, is transmitted through the channel of manufacturing, distribution and consumer prices.

The prices of the products produced by the industry occupy little attention, when their evolution has been spectacular in the last year. The industrial goods price index (IPRI) makes this clear. In January, the IPRI grew at an annual rate of 8.2%. But it comes from offering much higher figures, with annual growth rates of 47% in March, or 15.6% in April (both data from 2022), if we take into account all industrial products except energy.

Evolution of the Industrial Price Index, IPRI, from January 2022 to January 2023. General and general index without energy (%).
Source: INE

The formation of industrial prices, sooner or later, begins to be transferred to the consumer prices of manufactured goods, all included in underlying inflation. The industrial price index of those companies that specifically produce non-durable consumer goods grew in January at an annual rate of 15.65%, more than double the CPI. And specifically in the food industry, price growth has been 20.4%.

These data help to understand why underlying inflation has performed so negatively in recent months (at least partial transfer of costs to prices) and why it has such a significant impact on people’s standard of living. The disaggregated information from the CPI for January allows us to study how the prices of certain groups of goods and services in the shopping basket (known as rubrics).

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Annual growth of the CPI headings that have grown above core inflation (7.5% per year in January 2023).
Source: Own elaboration based on INE data

The annual growth of certain expenditure headings (those that have grown above core inflation) are shown in the attached graph. Sugar has grown by 52% in the last year, milk by 33%, oils by 31%, eggs by 27%. Nothing that Spanish citizens who balance their budgets doing the daily shopping don’t know.

The trend continues

These elements seem to herald a future where the evolution of underlying inflation continues to give us bad news due to its persistence over time, if not because it continues its upward trend. This may contribute to increasing inflationary tensions within the Spanish economy and the growing concern of the population as a whole about inflation, which they clearly perceive in their daily shopping basket.

This scenario, amplified by the electoral situation of the coming months, is propitious to demand corrective, compensatory policies, and other urgent measures that may have different fortunes and success in this to subdue a phenomenon as complex and persistent as inflation.

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