Wednesday, 20 of June of 2018

Economics. Explained.  

Producer Price Index

June 13, 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 (the red line) jumped 0.5% in May as energy prices surged.  This series rose 0.1% in April.  During the past year this inflation measure has risen 3.1%.  The PPI has been moving steadily higher.

Excluding food and energy producer final demand prices (the pink line) rose 0.3% in May after having climbed 0.2% in April.  They have risen 2.4% since April of last year.  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 jumped 1.0% in May after having been unchanged in April. These prices have now risen 4.3% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.3% in March, April, and May.  During the past year the core PPI for goods has risen 2.5% (right scale).  It has been rising at about that pace for the past year.

Food prices rose 0.1% in May after having fallen 1.1% in April.  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 risen 0.5%.

Energy prices surged upwards by 4.6% in May after having risen 0.1% in April.  Energy prices have risen 16.0% in the past year.  These prices are also very volatile but the recent upswing seems to reflect a significant quickening of 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 is talking about an increase in its crude oil output.  As a result, oil prices have fallen about 8.5% in the past several weeks from a mid-May peak of $72 to about $66 currently.  Thus, the May surge in energy prices will quickly be reversed.

The PPI for final demand of services rose 0.3% in May after having risen 0.1% in April.  This series has risen 2.4% over the course of the past year (left scale).   Changes in this component largely reflect a 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 was unchanged in May after having fallen 0.1% in April.  It has climbed 2.2% 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 both manufacturing and non-manufacturing firms.  In the case of manufacturing firms the chart looks like this:

And for non-manufacturing firms it looks like this:

In both cases, the run-up in prices was widespread.  It was not just energy prices.  Once again, 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 3.8%, 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 2.3% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

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