Supply bottlenecks visible in inflation

Prices of raw materials and intermediate goods are increasing

The principal factor behind the rise in commodity and intermediate goods prices is the sharp pick-up in global demand amid an accumulation of supply constraints. The successful vaccination campaigns and ample government support have boosted demand for consumer goods in developed countries. Low initial company stock levels and multiple global trade disruptions have made it difficult for businesses to keep up with increasing consumer demand. For example, there are great shortages of key intermediate goods such as semiconductors, metals, rubber and wood, and there is a shortage of shipping containers, which translates into higher commodity prices and transportation costs (see Figure 1). As a consequence, businesses face rising production costs, resulting in higher consumer prices. Prices of wood and iron ore have meanwhile fallen sharply, driven by increased supply and lower demand. This goes to show that producer prices may ease rapidly once supply constraints have been resolved.

Figure 1. Price developments since the COVID-19 pandemic
Index: April 2020 = 100; 4-week moving averages

Pass through of higher producer prices to consumer prices

Producer prices are much more volatile than consumer prices. In the past, for many goods, changes in producer prices were not passed through to consumer prices to any great extent. Producers generally pass on cost increases to consumers with a delay and only in part. Often a producer price increase has already evaporated before consumer prices are adjusted. However, with cost increases now being so substantial and sustained, some product categories do experience noticeable consumer price increases, as Figure 2 shows. In particular, these are goods containing wood, such as home and garden furniture, but also goods that depend on chips, such as monitors, other computer accessories and cars. Due to the shortage of these goods, consumers are turning to substitute goods, which means these goods are likewise experiencing an upward price effect. For example, there has been a slight increase in used car prices, for which consumer demand has gone up as the shortage of chips limits the production of new cars. For some of these goods, the increased demand at the height of the COVID-19 crisis also plays a role. Computer accessories, for example, were in great demand due to working from home.

Figure 2. Pre-pandemic and current inflation in the Netherlands
Percentages

The high inflation rates for precisely these tradable goods is striking, because it is these goods that have contributed to low inflation in recent years. For example, for the Netherlands over the period 1996-2020, there is a marked correlation between import intensity and inflation per product category. High import-intensity goods and goods originating from outside the EU contributed to lower inflation rates over this long period.

The duration of supply constraints determines the impact on longer-term inflation

The supply constraints that businesses face are mainly due to temporary friction that arises in the transition to a post-COVID-19 economy. As demand for goods normalises and shifts further towards services, and as more containers become available and new chip production facilities are built, inflationary pressures are likely to ease and prices may actually fall. However, there is much uncertainty about the duration of this transition period. The longer these problems persist, the more likely it is that higher inflation will affect the behaviour of consumers and businesses. For example, higher inflation may, through higher wage demands by employees and higher wage costs for businesses, push up inflation and set off a wage-price spiral. Although we have not seen any evidence of this as yet, inflation expectations on financial markets have recently risen towards 2%. This is reason enough to keep a close eye on these dynamics. We will soon publish a more comprehensive analysis of recent inflation developments.