Wednesday, 15 of August of 2018

Economics. Explained.  

Producer Price Index

August 9, 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 were unchanged in July after having risen  0.3% in June.  During the past year this inflation measure (the red line) has risen 3.2%.  The PPI has been moving steadily higher.  In July falling prices for food and energy countered a small increase in the so-called core PPI.

Excluding food and energy producer final demand prices rose 0.1% in July after having risen 0.3% in both May and June.  They have risen 2.7% since April 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 rose 0.1% in both June and July. These prices have now risen 4.4% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods has risen 0.3% in each of the past five months.  During the past year the core PPI for goods (the light green line) has risen 2.8% (right scale).

Food prices fell 0.1% in July after having declined 1.1% in June.  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 1.0%.

Energy prices dropped by 0.5% in July after having risen 0.8% in June.  Energy prices have risen 16.8% 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.  Our sense is 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 declined 0.1% in July after having risen 0.4% in June.  This series has risen 2.6% over the course of the past year (left scale).   The July drop was caused by an 0.8% decline in the trade services category which largely reflects 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 both June and July.  It has climbed 2.4% 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 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.  In June and July this series actually declined from 79.5 in May to 73.2 by July.  This means that prices continued to climb in those two 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.

And for non-manufacturing firms it looks like this.  The conclusion is largely the same.

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 3.9 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 2.2% in 2018 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

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