ECB Bulletin: Effect of exchange rates is strongest and most immediate for inflation

The European Central Bank (ECB) published its monthly economic bulletin on Wednesday, explaining the significance of exchange rates in shaping up the outlook for inflation.

Key Points:

Exchange rate pass-through into euro area inflation

Current rise in TARGET balances does not signal increasing financial market stress

The effect of the exchange rate is strongest and most immediate for import prices, and declines along the pricing chain.

The size and speed of the exchange rate pass-through seems to differ across product categories, indicating that cost structures and pricing decisions at the firm level are important for gauging the exchange rate effects at the aggregate price level.

Estimates of exchange rate pass-through for the euro area vary considerably across models and across time periods.

Recent studies advocate looking at the underlying economic shocks when analysing the responsiveness of import and domestic prices to exchange rate changes.