August 9, 2019

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 July after having climbed 0.1% in both May and June.  During the past year this inflation measure (the red line) has risen 1.7%.

Excluding food and energy producer final demand fell 0.1% in July after having risen 0.3% in June.  This is the first decline in this series since February 2017..  The core PPI has risen 2.1% in the past year (the pink line in the chart above).  This series was steadily accelerating for a couple of years, but it has been steadily drifting lower in the past 12 months or so.

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

The PPI for final demand of goods rebounded by 0.4% in July after having fallen 0.4% in June. These prices have now risen 0.4% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods rose 0.1% in July after having been unchanged in April, May, and June.  During the past year the core PPI for goods (the light green line) has risen 1.2% (right scale).

Food prices rose 0.2% in July after having jumped 0.6% 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 risen 2.5%.

Energy prices climbed 2.3% in July after having fallen 3.1% in June and 1.0% in May.  The July increase seems to reflect the market’s fear of an interruption in the supply of oil caused by Iran’s attacks on several oil tankers in the Persian Gulf.  Energy prices have fallen 4.5% in the past year.   Crude oil output in Venezuela and Iran has been falling steadily and Saudi Arabia  cut its oil output in an effort to boost prices, but U.S. production has continued to surge to a new record high level of 12.3 million barrels per day and that increase in output has more than countered the OPEC shortfall.

The PPI for final demand of services fell 0.1% in July after having risen 0.4% in June and 0.3% in May.  This series has risen 2.3% over the course of the past year (left scale).   The PPI for final demand of services excluding trade and transportation (the light blue line) dropped 0.3% in July after having been unchanged in June and having jumped 0.5% in May.  It has climbed 1,7% in the past year. The July drop was largely attributable to “guest room rentals” (think hotels and motels) which fell 4.3%.

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 well beyond full employment.  As a result, wages pressures have begun to climb, but the resulting upward pressure on inflation has been countered by an increase in productivity.  Unit labor costs, labor costs adjusted for the increase in productivity, have fallen 0.8% in the past year.  Compensation climbed 1.5% during that period of time but that increase was almost entirely offset by a 2.4% increase in productivity.  No wonder the seemingly tight labor market is not putting upward pressure on inflation — the increase is being entirely offset by an increase in productivity.  That means that firms have no real incentive to raise prices — workers have earned their fatter paychecks.

We expect the core CPI to increase  2.3% in 2019 after having risen 2.2% in 2018.

Stephen Slifer


Charleston, SC