Wednesday, 17 of October of 2018

Economics. Explained.  

Producer Price Index

October 10, 2018

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand rose 0.2% in September after having declined 0.1% in August.  During the past year this inflation measure (the red line) has risen 2.7%.  The PPI has been moving steadily higher for some time but its rate of ascent appears to have slowed.

Excluding food and energy producer final demand prices also rose 0.2% in September after having declined 0.1% in August.  They have risen 2.5% since August of last year (the pink line).  This series has been steadily accelerating for the past two years.  Inflationary pressures are gradually re-surfacing.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods declined 0.1% in September after having been unchanged in August. These prices have now risen 3.1% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.2% in September after having been unchanged in August.  During the past year the core PPI for goods (the light green line) has risen 2.6% (right scale).

Food prices fell 0.6% in both August and September.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have declined 1.5%.

Energy prices declined 0.8% in September after having risen 0.4% in August.  Energy prices have risen 9.5% in the past year.  These prices are also very volatile but the recent upswing seems to reflect a pickup in GDP growth around the globe, the cutback in global supply by OPEC, and a state of complete chaos for oil production in Venezuela.  However, U.S. oil output is now surging and OPEC has increased its crude oil output.  The Department of Energy believes that the recent surge in energy prices will be at least be partially reversed between now and yearend.

The PPI for final demand of services rose 0.3% in September after having declined 0.1% in both July and August.  This series has risen 2.4% over the course of the past year (left scale).   Both the September jump in service goods prices and the August drop were partly caused by a 0.6% decline in the trade services category in August followed by a rebound of 1.8% in such prices in September.  These swings largely reflect the change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular). .  The PPI for final demand of services excluding trade and transportation (the light blue line) increased 0.3% in June, July and August, and September.  It has climbed 2.8% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

The recent increases in producer prices were foreshadowed by the results of the Institute for Supply Management’s series on prices paid by manufacturing firms.  In the case of manufacturing firms the chart looks like the one below.  Price pressure were steadily building for six consecutive months.  Specifically, the price component rose steadily from 64.8 in November of last year to 79.5 in May.  The fact that every month was above 50.0 meant that prices producers were paying increased every single month.  Given that the level of the index steadily rose during that period of time indicates that price pressures were intensifying every single month.  However, from June through September this series actually declined to 66.9  This means that prices continued to climb in those four months, but the rate of increase was less than in other recent months.  Hopefully, this means that the steady upward pressure on the PPI is beginning to abate.

We believe this escalation in the prices that producers are having to pay reflects stronger GDP growth around the globe.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 3.7% the labor market is beyond full employment.  As a result, wages pressures have begun to climb, but much of the upward pressure on inflation should be countered by an increase in productivity.  Nevertheless, the tighter labor market should exert at least moderate upward pressure on the inflation rate.

Some upward pressure on labor costs, rents, and the cost of materials will put upward pressure on inflation.  We expect the core CPI to increase 2.4% in both 2018 and 2019 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

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