Inflation Takes a Chill Pill, Leaving Plenty of QE Wiggle Room

The seasonally-adjusted Producer Price Index for finished goods decreased 0.7 percent on the month in March, according to data released by the Bureau of Labor Statistics on Wednesday. This is the largest sequential decline in three years, and is in line with economist expectations. On the year, unadjusted producer prices are up 0.6 percent, the smallest rise in nearly a year.

The PPI measures prices changes from the perspective of the seller. This makes the headline index a gauge of the prices received by producers for a fixed basket of goods. So, although the Consumer Price Index is the core measure of inflation, changes in the PPI index can be used as a leading indicator of inflation.

The core index, which excludes typically volatile food and energy prices, increased 0.1 percent. Economists were expecting a marginally higher increase of 0.2 percent, but regardless, the data show that there is very little inflation at the producer level. This is a positive sign for Fed doves, many of whom are in favor of continued quantitative easing. If, on the other hand, inflationary pressure was evident at the producer level, Fed hawks would have gained leverage in their case to tighten policy.

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Source: U.S. Bureau of Labor Statistics

Monthly changes in the headline PPI index are generally volatile because of fluctuations in food and energy prices. In April, the finished goods index for foods declined 0.8 percent, led by a 10.6 percent decline in the index for fresh and dry vegetables, as well as a significant drop in meat prices. The finished energy index declined 2.5 percent. Over 90 percent of the drop is attributable to a 6.0 percent decline in gasoline prices.

Foods and Gas PPI

Source: U.S. Bureau of Labor Statistics

Since the finished goods index covers final products bought from producers by businesses — which will either sell them directly to consumers or use them as capital equipment — increases in the price of finished goods can be passed on to the market, depending on conditions. With this in mind, investors can use the various PPI indexes to track inflationary pressure before it really manifests in the consumer market. If finished goods prices advance sharply for a number of consecutive months, these increases could be passed on to consumers.

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Likewise, price increases in crude goods or intermediate goods can be passed on to producers. However, price changes in these categories have been relatively muted recently and show little signs of inflationary pressure. The index for crude goods decreased by 0.4 percent in April following a 2.5 percent decline in March. The index for intermediate goods decreased by 0.6 percent in April following a 0.9 percent decline in March.

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