Core inflation

Core inflation is the rate of consumer price growth calculated on the same basket as the headline index, but without the items whose prices move for reasons only loosely tied to demand and monetary conditions: fruit and vegetables and other food with marked seasonality, motor fuel, and the tariffs and services whose prices are set or capped by the state. What remains is regarded as the persistent part of price dynamics, the part that interest rate policy can actually influence.

How the adjusted index is built

The starting point is the consumer price index: the same set of goods and services, the same consumer spending weights, the same observed prices. A list of items fixed by the methodology is struck out of the set, and the weights of the remaining items are rescaled proportionally so that they once again add up to a full basket. The list of exclusions changes rarely; otherwise figures for different periods would no longer be comparable. There is also an alternative technique: instead of a fixed list, the extreme values of the price distribution are discarded. In this variant, what is excluded is not a specific product but any product that strayed far from the overall picture in a given month.

Hence the indicator's value to the regulator: a seasonal harvest or a one-off jump at the petrol pumps distorts headline inflation for months but says nothing about overheating demand, whereas rising prices in the adjusted part of the basket usually go hand in hand with rising inflation expectations.

What exactly is left out

The excluded items lead a life of their own on commodity markets, and their annual performance can be seen directly on the platform:

Fuel, grain and oilseeds reach supermarket shelves and petrol stations with a lag, but they do reach them; by excluding them from the calculation, statistics do not deny this price increase but simply move it into a separate observation.

Where the indicator misleads

The first mistake is to treat the adjusted index as a measure of the rising cost of living. Food and petrol do not disappear from a household budget, and the gap between headline and core inflation persists for quarters, not weeks.

The second is to treat "adjusted" inflation as a synonym for monetary inflation. Through imported components and exchange rate pass-through, non-monetary inflation, which interest rates cannot cure either, seeps freely into the core part of the basket.

The third concerns the bond market: the face value of inflation-linked OFZ bonds and breakeven inflation are tied to the headline consumer price index, not the core one. Comparing linker payments with core inflation is an error in the quantity itself, not in its interpretation.