The prices of industrial goods and services have not been immune to the surge in energy prices

Last year, energy prices in Europe faced the sharpest increase in historical terms. It had a significant impact on headline inflation directly via higher consumer energy prices (car fuel, natural gas, electricity, heat energy and solid fuel), as well as indirectly– energy resources are used in the manufacturing of industrial goods and provision of services, thus affecting the costs and the final prices of these products. What impact have energy prices had on the prices of industrial goods and services?

In this article I will try to answer the following questions:

1. What is the impact of energy prices on core inflation [1] or the part of inflation excluding food and energy?
2. Which industrial goods and services are most exposed to energy price increases?

The rise in energy prices slows down

Over the last year, the surge in energy prices has been impressive, with annual growth rates exceeding 60%. However, as the global oil and natural gas prices fell, the slowdown in energy inflation is being gradually observed in Latvia as well (see Chart 1). Since the dynamics of headline inflation is closely linked to energy prices, we can soon expect a slowdown in inflation – our flash inflation estimates (Inflation OMA) show that this could happen as early as March.

The soaring core inflation owes to the increase in energy prices

Energy, either car fuel, electricity, heat energy or other forms of energy, is used in the manufacturing of various industrial goods and the provision of services, thereby indirectly affecting the costs and the final prices of these goods and services. What has been the impact of the steep increase in energy prices on core inflation, the variable which excludes the most volatile price groups (energy and food) and characterises the persistence of price rise? Our estimates show that the impact of higher energy prices on core inflation has been significant. Almost half of the core inflation increase last year is attributed to the increase in energy prices (see Chart 2). Namely, due to the rise in energy prices, the prices of industrial goods and services at the end of last year were almost 6 percentage points higher than the year before.

Energy-sensitive prices have largely contributed to the rise in prices of industrial goods and services

Not all industrial goods and services are equally sensitive to energy price fluctuations. I use three methods to determine which goods and services are particularly sensitive to energy price fluctuations (see the technical details in the annex):

• a) statistical correlations, which demonstrate simple statistical relationships between energy prices and prices of industrial goods and services;
• b) sectoral energy intensity – I identify the sectors where energy resources play a relatively important role using input-output tables;
• c) econometric relationships – I assess the impact of the energy price increase on individual prices of industrial goods and services using bivariate vector autoregression models.

Energy-sensitive consumer prices are selected according to these methods [2] and reflected in Table 1 for industrial goods and in Table 2 for services.

Our estimates show that the prices of energy-sensitive industrial goods have recorded a notable increase and made a significant contribution to inflation of industrial goods since the beginning of last year (see Chart 3). Likewise, looking at services inflation, a particularly steep rise was observed in the prices of energy-sensitive services and their contribution to inflation of services (see Chart 4). Meanwhile, note that there was also a significant increase in prices of not energy-sensitive services, which could possibly be related to a rather high wage increase (compared to other euro area countries).

Summary

The rise in energy prices was record-high last year. It had a significant impact on headline inflation directly through the prices of energy goods, and indirectly through an increase in production costs of industrial goods and services. The increase in energy prices has significantly affected core inflation, explaining almost half of the rise in core inflation last year. At a granular level, the rise in energy prices has affected both the prices of industrial goods and services.
The large wave of energy price increase is gradually receding. Since September of last year, the prices of energy commodities – oil, natural gas and electricity – have fallen significantly, also reducing consumer energy prices. The increase in the prices of industrial goods and services was largely determined by the rise in the prices of energy-sensitive goods and services, therefore the core inflation is also expected to decrease in the second half of this year.

Sources:

• Francesco Corsello & Alex Tagliabracci, 2023. "Assessing the pass-through of energy prices to inflation in the euro area," Questioni di Economia e Finanza (Occasional Papers) 745, Bank of Italy, Economic Research and International Relations Area.
• Philip R. Lane’s blog “Inflation Diagnostics”, Frankfurt am Main, 25 November 2022. 

Table 1. Industrial goods that are considered as energy-sensitive

Notes: Central Statistical Bureau; author's calculations. The table shows only those HICP items that are included in the energy-sensitive category, based on one of the three criteria. The bivariate VAR models show that the respective HICP item statistically significantly reacts to the HICP energy shock (2 standard deviations). The share of industrial goods in the consumer basket is 21.39%, while the share of energy-sensitive industrial goods is 8.71%. COICOP classification contains 33 items of industrial goods. Individual items that are not energy-sensitive according to the criterion of VAR models are considered energy-sensitive either because of the high correlation or because of the relatively high share of energy from the input/output tables.

Table 2. Services that are considered as energy-sensitive

Notes: Central Statistical Bureau; author's calculations. The table shows only those HICP items that are included in the energy-sensitive category, based on one of the three criteria. Correlations have been computed between the annual growth rates of HICP energy and the respective HICP item. The trivariate VAR models (HICP energy, wages, HICP item) show that the relevant HICP item statistically significantly reacts to the HICP energy shock. The share of services in the consumer basket is 26.41%, while the share of energy-sensitive services is 10.97%. COICOP classification contains 35 items of services. Individual items that are not "energy-sensitive" according to the criterion of VAR models are considered "energy-sensitive" either because of the high correlation or because of the relatively high share of energy from the input/output tables. 

[1] Core inflation means the annual change in the Harmonised Index of Consumer Prices (HICP) excluding food and energy, or, respectively, the change in prices of industrial goods and services. In the article, these three terms are used interchangeably.

[2] The fact that certain HICP components are not included in the list of energy-sensitive items does not mean that they do not react to energy prices at all. This could mean that either the share of energy in the manufacturing process is small compared to other products, or historically the relationship between energy prices and the prices of the product concerned was weak.