What is core inflation?
“Core inflation” is an important aspect of inflation that deserves special attention. In the world of finance, understanding inflation is essential to making informed investment, savings and spending decisions. In this blog post, we will explore in detail what underlying inflation is, its importance in the economy, and how it relates to digital transformation in the fintech arena.
What is core inflation?
Core inflation is a key measure for assessing price change in an economy, but what makes it different from headline inflation? Core inflation refers to the increase or decrease in the prices of goods and services, excluding volatile items that could distort the actual perception of the inflationary trend. These volatile elements typically include fresh food, energy and other products with prices subject to seasonal fluctuations or specific events.
Thus, core inflation provides a more stable and lasting picture of inflation in an economy. By removing temporary and seasonal factors, policymakers and analysts can better identify underlying inflation trends and make better decisions.
This measure is particularly valuable for central banks and investors, as it allows them to understand the true long-term inflation rate and adjust their strategies accordingly.
Core inflation indicators
There are several indicators for measuring core inflation, and each can offer a slightly different perspective. Two of the most commonly used are:
- Underlying Consumer Price Index (CPI):
The CPI is a widely recognized measure that tracks changes in the cost of a basket of goods and services representative of average household consumption. The underlying CPI excludes the volatile elements mentioned above and provides a more accurate picture of long-term inflation.
- Underlying Producer Price Index (PPI):
The PPI focuses on price changes in goods and services before reaching the final consumer. Like the underlying CPI, the underlying PPI eliminates volatile elements and provides crucial information about inflation upstream in the supply chain.
Examples of core inflation
To better understand the concept of core inflation, it is useful to explore some examples that illustrate how this measure works and how it differs from headline inflation.
- Example 1: The seasonal rise in oil prices
Imagine that a country experiences a significant increase in oil prices due to geopolitical tensions in a major producing region. This could lead to a rapid increase in the cost of gasoline and thus in the prices of goods and services that depend on transportation. However, core inflation excludes this temporary increase and focuses on the overall price behavior of non-oil goods and services, providing a more stable view of true long-term inflation.
- Example 2: Seasonal Variations in Fresh Food Prices
In another scenario, suppose a country experiences a dry season that severely affects the production of fresh foods, such as fruits and vegetables. As a result, the prices of these foods soar during the lean season. However, core inflation would ignore these temporary increases and focus on the overall price behavior of goods and services, providing a more accurate picture of the inflationary trend without the distortions caused by seasonal factors.
These examples show how core inflation is essential for separating temporary or event-specific effects from overall price changes in an economy.
Impact on the economy, businesses and employment
Core inflation is a critical indicator that affects the economy, businesses and employment in a number of ways. Below, we will explore how this factor influences these key aspects:
Economic stability and monetary policy
Core inflation is critical to assessing a country’s economic stability. When core inflation remains within a target range, it indicates a balanced and healthy economy. This is crucial for the smooth functioning of businesses, as it provides a more predictable environment for investment and financing decisions. Monetary policy implemented by central banks plays an important role in managing core inflation. Changes in interest rates and other measures can influence long-term inflation and affect companies’ profitability and financial decisions.
Impact on savings, investments and wages
Core inflation directly influences the purchasing power of savings and investments. When inflation is high, the real value of money declines over time. For businesses, this means considering how to protect and grow investor capital in an inflationary environment. In addition, underlying inflation can have an impact on workers’ real wages. If wages do not increase in proportion to inflation, employees may experience a loss of purchasing power, which can affect their job satisfaction and talent retention.
Underlying inflation and employment
Underlying inflation can also influence employment dynamics. When operating costs increase due to inflation, some companies may be forced to restrict hiring or even reduce headcount to maintain profitability. In addition, underlying inflation can affect consumer confidence and demand, which could influence growth in certain sectors and ultimately employment generation.
Risk management and financial planning
Underlying inflation implies financial risks for companies. Therefore, risk management becomes essential to protect against possible negative effects. CFOs (Chief Financial Officers) must anticipate how underlying inflation could affect operating costs and revenues and plan budgets and pricing accordingly. Effective financial risk management enables companies to mitigate the negative consequences of underlying inflation and maintain economic stability.
Impact on companies and SMEs
Core inflation can have a significant impact on businesses, especially SMEs, as it affects operating costs as well as revenues and profitability. Let’s take a deeper dive into how core inflation can affect businesses and how to manage it effectively.
- Rising operating costs
When underlying inflation increases, a company’s operating costs also tend to increase. This can be due to increases in input prices, such as raw materials, energy and transportation, which directly affect production and the supply chain. For SMEs with tight margins, these increases can represent a considerable challenge and require adjustments in cost structure and purchasing strategy.
- Pressure on selling prices
As operating costs increase due to underlying inflation, companies may feel pressure to pass on these increases to the selling prices of their products and services. However, doing so can affect consumer demand, especially in an economic environment sensitive to price changes. Companies must strike a balance between maintaining profitability and remaining competitive in the marketplace.
- Impact on profitability
Underlying inflation can erode a company’s profitability if revenue increases do not adequately offset cost increases. This is especially relevant for SMEs, as they may be less able to absorb the impacts of inflation compared to larger corporations. A CFO must carefully assess how underlying inflation affects the company’s profitability and take steps to keep it healthy.
- Financial contracts and agreements
Underlying inflation can affect the financial contracts and agreements that a company has in place. For example, rental or loan contracts may be indexed to inflation, which means that periodic payments increase over time. For a company, this can result in higher outlays and additional financial commitments.
Underlying inflation management in the company and its impact on CFO
- Ongoing monitoring and analysis
The first step in managing core inflation is to constantly monitor and analyze price changes and their impact on the business. CFOs must be aware of inflationary trends and assess their impact on costs, revenues and profitability.
- Budget planning
Proper budget planning is essential to anticipate and manage the effects of underlying inflation on the business. CFOs should consider potential cost increases and adjust budgets accordingly. They must also evaluate the need to review selling prices and determine whether it is possible to implement gradual or strategic increases.
- Negotiating with suppliers and customers
The CFO can play a key role in negotiating with suppliers and customers to mitigate the effects of underlying inflation. By seeking long-term agreements or looking for cheaper sourcing alternatives, companies can reduce the impact of input price increases. In addition, they can explore pricing strategies that are reasonable for customers and that maintain the company’s profitability.
- Financial risk management
Underlying inflation also involves financial risks that the CFO must consider in its management. Financial instruments such as derivatives can help protect the company against adverse movements in input prices or foreign currency, which may be relevant for those companies that have exposure to external inflationary factors.
Snab: Simplifying treasury to cope with core inflation
Underlying inflation can put significant pressure on companies and SMEs, as it can affect their operating costs, profitability and financial decision making. However, in this challenging context, Snab emerges as a reliable and effective solution to optimize financial management and overcome the challenges of core inflation.
Snab offers a treasury and digital banking platform that provides efficient solutions to address underlying inflation. The ability to centralize treasury and financial data on a single platform allows companies to have a comprehensive view of their financial situation and react nimbly to economic changes by making informed financial decisions and mitigating the risks associated with inflation.
In addition, automating invoice management with Snab reduces time and human error, which is essential in an inflationary context where costs can fluctuate. By having real-time cash control and constant access to up-to-date information, companies can make informed financial decisions and adapt quickly to market changes.
In this way, Snab is positioned as a valuable tool to address the impact of underlying inflation on businesses and SMEs. By offering efficient solutions that optimize financial management, Snab enables companies to overcome economic challenges in an ever-changing environment, providing confidence and security in making informed financial decisions.