Explained: What is core inflation and what it says about the state of the European economy

The new year has kicked off with a first dose of good news: after months breaking all-time records, inflation in the eurozone has begun to cool down, returning to single-digit territory.

The latest flash estimate released by Eurostat shows that annual inflation stood at 9.2% in December, significantly down from the 10.1% registered in November.

Inflation of energy products, the main driver behind last year’s surge, receded sharply, from 34.9% to 25.7% in one month, while food prices saw a moderate decrease.

However, one key indicator actually went up: core inflation, which climbed from 5% in November to 5.2% in December, the highest figure since the creation of the single currency.

Why is that?

Core inflation offers a more precise picture of the state of the economy by excluding the prices of energy, food, alcohol and tobacco, which tend to be more volatile than others. And even if prices go up, as they did over the past months, people continue to purchase these essential products at a consistent pace.

In other words, nobody is going to stop going to the supermarket because of inflation. 

Core inflation goes beyond these basic products and touches upon the variety of goods and services that we consume on a regular basis, sometimes for sheer pleasure, such as renting a car, buying a new smartphone, getting a haircut and going to the movies.

High core inflation, therefore, means that everything around us is becoming more expensive. 

This is why so many economists and policy-makers now speak of “broad-based” inflation, a term that underlines how ubiquitous and pervasive this phenomenon has turned.

“All producers and sellers somehow try to compensate for the big shock in their energy costs,” Zsolt Darvas, a senior fellow at Bruegel, a Brussels-based economic think tank, told Euronews. “So, it’s quite natural, in my view, that inflation became widespread across all kinds of different goods and services.”

The longer core inflation remains high, the greater the pain for consumers, who will see their salaries and personal savings lose value over time. This leaves them with no choice but to hope their sympathetic employers will offer them a generous raise to keep up with the upward trend.

“If wages won’t increase as much as inflation,” Darvas said, “then in the medium- and long-term, the purchasing power will be reduced permanently and that will result in lower consumption, lower demand and consequently a lower economy.”

Watch the video above to learn more about core inflation.