ANNUAL REPORT 2008 - Polymer Bank Notes of the World

commodity prices (see Box 4). Conversely, thesubsequent rapid decline in HICP inflation, to1.6% by the end of the year, resulted from thestrong decline in crude oil prices and reductionsin the prices of a broad range of other globalcommodities, including food, plus a favourablebase effect, in a context of rapidly deterioratingeconomic activity.Box 4COMMODITY PRICES AND HICP INFLATIONThe prices of a broad range of commoditiesrose sharply in the period between the start of2005 and July 2008 (see Chart A). They havedeclined rapidly since then, amid the markeddeterioration in global economic activity.These developments – in particular those in oiland food prices – have had a major bearing onconsumer prices in the euro area and largelyexplain the spike in overall HICP inflationin 2008. This box reviews the effects ofcommodity prices on euro area inflation. 1Direct and indirect effectsChart A Commodity prices(monthly data in euro; index: 2000 = 100)300250200150100food and tropical beveragesmetalsoil300250200150100Commodity price increases affect HICPinflation directly through their immediateeffect on the consumer prices of energy andfood, which represent almost 30% of theoverall HICP. They may also have an indirect effect on consumer prices through producer prices,as firms facing higher input costs pass these cost increases on to sales prices in order to maintainor restore their profit margins.The extent to which cost increases are passed on to further stages of production and to consumersdepends on several factors, including competitive pressures in the market and business cycleconditions. As cost shocks take time to work through the supply chain, indirect effects aregenerally thought to materialise with longer time lags and to last longer than direct effects.Turning to the data, most of the increase in headline HICP inflation from August 2007 was dueto the direct and indirect effects of the commodity price shock. In line with this, processed andunprocessed food and energy prices – the HICP components more directly exposed to the shock –rose substantially up to July 2008, whereas measures of inflation excluding food and energyremained largely unchanged over the period (see Chart B).Indirect effects also appeared to emerge in other HICP components that use oil and raw food asa production input. For example, within the services component, the prices of transport-relatedservices, package holidays and restaurants – which use oil and food as production inputs – rose502000 2001 2002 2003 2004 2005 2006 20072008Sources: Hamburg Institute of International Economics and ECBcalculations.501 See the article entitled “Oil prices and the euro area economy” and the box entitled “Recent oil price developments and their impact oneuro area prices” in the November 2004 and July 2004 issues of the ECB’s Monthly Bulletin respectively.ECBAnnual Report200855