Domestic and cyclical inflation in the euro area

The ECB’s inflation target is formulated in terms of headline inflation. However, domestically determined inflation features prominently in the monetary policy transmission mechanism and in gauging underlying inflation, making it important to assess it regularly. The ECB monitors various proxies for domestically determined inflation, including: (i) “domestic inflation”, which aggregates inflation items with a low import share; and (ii) “Supercore” inflation, which aggregates inflation items found to be sensitive to the aggregate business cycle. This paper provides a detailed overview of the methodologies used to derive both these indicators and updates the relevant input data. It suggests refinements to the methodologies that would also make these measures more robust in future updates. In addition, it explains the changes in these indicators due to the introduction of a new classification of consumer goods and services (European Classification of Individual Consumption according to Purpose (ECOICOP) version 2) for the compilation of the Harmonised Index of Consumer Prices (HICP). First, on domestic inflation, the paper explains the new underlying data on the import share of inflation items made available since the publication of its methodology, and provides an update, combined with a few methodological changes (for example, moving to a constant composition of the included items). Second, with regard to Supercore inflation, the paper explains the challenges of identifying a cyclical inflation indicator for the euro area, especially in the light of the recent large shocks, and explores modelling approaches. It proposes some refinements to the previous methodology, while keeping a Phillips curve approach as a focal point in the analysis. For both indicators, the paper presents the updated indicators and some key properties.