You are currently viewing A new ECB inflation indicator confirms the worst omens for the economy

Inflation is scorching virtually every economy in the world (there are honorable exceptions). However, in the euro zone there has been an attempt for quite some time to play down the importance of this price increase because it responds to global and energy factors that are not very controllable. This has been the mantra used by politicians and economists for months. Although part of this hypothesis is true, it could soon cease to be so, as revealed by a new inflation indicator published by the European Central Bank.

This new yardstick for measuring inflation created by the ECB reveals that an increasing part of the inflationary pressures in the euro zone are the product of the domestic market itself. To perform this analysis, central bank economists have compiled the LIMI index (Low Import Intensity)which isolates goods and services that have a low import intensity, that is, goods and services that have been produced to a greater extent within the euro area and with inputs that are less exposed to international prices.

The ECB acknowledges that the LIMI inflation indicator “generally shows a strong link to the business cycle. In principle, the LIMI inflation indicator should have a relatively high sensitivity to internal slack.” This means that if this inflation indicator rises, it is because the eurozone economy could also be overheating (such as the case of the United Kingdom or the USA).

How does the LIMI work?

The new inflation indicator only takes into account components with Low Import Intensity or LIMI for its acronym in English and includes components such as housing rental, domestic services, maintenance, repairs, health, aesthetics, hairdressing, dental services or education. This indicator “suggests that, although the strong increase in headline inflation is mainly explained by imported inflation, domestic inflationary pressures also increased last year,” according to the report published this week by the central bank.


Different indices of core inflation

The LIMI indicator has already exceeded 3% year-on-year (headline inflation is now over 8%) and stands at the maximum levels of the calculations made by the central bank. The ECB itself explains that “The LIMI should be used as a complementary indicator within a broader set of indicators of underlying inflation. Furthermore, an analysis based on these indicators should be complemented with a more structural analysis of the determinants to better understand the inflation process. recesses of the economy, which in principle should be more protected from energy or fresh food shocks.

It is true that general inflation in the euro zone is seriously influenced by global factors (energy, chips, food…) that the ECB cannot directly influence through its monetary policy tools. But it also reveals that domestic inflation has been waking up for months How have they been announcing the underlying IPCA indicators? (does not weight energy or fresh food) and the strict underlying IPCA (it also leaves out other volatile prices such as tourism).

The ECB is ready to raise interest rates in July for the first time in more than a decade in response to rising prices in general, but above all to try to cut off this transmission that is infecting the most isolated places in the international economy ( hairdressers, repairs…).

The Governing Council is debating to what extent and how quickly borrowing costs should increase, since some of the members of the ECB defend that interest rates can do little in the face of inflation that is largely supply-side. However, data from the LIMI indicator increasingly supports central bank members who want to raise the price of money. Precisely, this new index is intended to be used as an additional tool to help in decision-making, as revealed by the ECB.

“Although the ECB’s inflation target is formulated in terms of general inflation, the concept of internal inflation has analytical relevance for monetary policy, since it occupies a prominent place in the transmission mechanism of monetary policy”, states the report .

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J. A. Allen

Author, blogger, freelance writer. Hater of spiders. Drinker of wine. Mother of hellions.