Business price expectations show no quick turnaround for eurozone core inflation

Looking at inflation expectations has become key in this day and age. All the more so now that European Central Bank (ECB) board member Isabel Schnabel explained at Jackson Hole that incoming inflation expectations data are an important input in policymaking as medium-term inflation expectations are harder to forecast right now. So let’s look at recent developments.

Since April, we have seen the number of businesses expecting to raise prices in the months ahead decline steadily. But they ticked up again in September according to the economic sentiment survey by the European Commission. What has driven the move? When looking at the development of selling price expectations by sectors since April, we find a strong correlation with the energy-intensiveness of production. Clearly, energy prices continue to be the key driver in determining whether prices need to go up or not.

At the same time though, we do notice that the August price peak has not resulted in a similar jump in selling price expectations that we saw in March. This suggests that weakening demand is starting to have an impact on whether businesses are comfortable pricing through to their consumers.

The fact that the peak in selling price expectations seems to be behind us gives the impression that some moderation in core inflation could be around the corner. The question is how fast this will actually start to have an effect. The problem with these business indicators for inflation expectations is that it lumps together companies selling directly to consumers and businesses further down the supply chain, like base metals for example.

To distinguish between sectors fueling pipeline inflation and those directly selling to consumers, we look at the final consumption expenditure by households from different sectors. While those sectors in most cases also sell wholesale, it at least gives an indication of whether consumer prices are currently being raised. We lump the ten sectors that sell most to consumers together to create a view of the selling price expectations among businesses selling to consumers. We also average the indicator for the 20 sectors selling to consumers least, which we count as the pipeline selling price expectations.

It still seems too early to call the peak in core inflation

While we see little difference between the two in selling price expectations historically, they have diverged much more in recent months. The decline in selling price expectations has been much stronger with pipeline sectors. The drop for businesses selling straight to consumers has been far smaller so far. What this tells us is that a quick drop in core inflation is not imminent despite energy price declines and weaker demand. Businesses are still trying to price through a lot of the earlier jumps in energy costs for the moment. This means that despite encouraging signs around prices, with energy costs dropping and weakening demand, it still seems too early to call the peak in core inflation.