Producer Price Index Business Definition
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- Producer Price Index (PPI). Why is this index published?
The indicator deserves some attention, because it is the first more or less significant indicator of inflation for the previous month.
Designation: PPI; basic (excluding food and energy) - Core PPI
Market sensitivity: quite high
Release date: as a rule, the third week of the next reporting month
Time: 8:30 am (US Eastern Standard Time)
Period: monthly
Published by: Bureau of Labor Statistics, Ministry of Labor
Description of the indicator
The series of publications of the Producer Price Index was opened in 1902, that is, this indicator is the first nationwide criterion of inflation. High inflation is the number one enemy for many financial assets, because it pushes up interest rates. That is why investors are interested in tracking the latest trends in this area. In this regard, the Producer Price Index, which is the first assessment of price pressure, is quite important for market participants. PPI is a criterion for changing the prices that manufacturers and wholesalers pay for goods at various stages of the production process. If producers pay more for incoming resources, it is likely that in the near future this will result in consumer inflation, and then the Consumer Price Index (CPI) will already grow.
Read more: What is the Consumer Confidence Index (CCI)
The producer price index is represented by a group of components. A separate index is calculated for each of the successive stages of production: raw materials, semi-finished products, finished products. It is the latter that most worries the financial markets, since it represents the final stage of the production process and depends on the previous stages. This indicator reflects the prices of products immediately before they hit the shelves of stores. If we examine the report on the components in more detail, we can understand why (at what stages) there is an increase in product prices.
It is customary to consider the percentage change in PPI relative to the previous month, as well as the change in annual terms. The second option is more intuitive and allows you to track trends. In addition to the standard Producer Price Index, we also consider its variety, cleared of the influence of food and energy prices, which allows us to discard volatile components and look at the basic dynamics.
In principle, the Producer Price Index and the Consumer Price Index tend to move in tandem in the medium term. An important difference between them is that PPI does not take into account the costs of services.
Calculation methodology
The methodology for calculating the producer price index involves the following stages.
Selection of basic industries. The method of calculating the PPI index assumes that it covers all the basic industries: mining and processing industry, light industry, mechanical engineering, agriculture, etc. Its value can be calculated for each individual industry, or for the entire economy as a whole.
Selection of a set of industrial products participating in the index. The main task at this stage is to create a representative sample that would objectively take into account the structure of manufactured industrial goods and consumed raw materials in each industry. The exact calculation of the inflation target will directly depend on the quality of the sample.
Determination of weight coefficients for each product. At the stage, it is necessary to objectively assess the specific weight of each industrial product included in the PPI index, so that the inflation target objectively reflects the change in the price level in industry.
In addition, the calculation methodology should take into account regional aspects, namely the fact that the price level for industrial goods may differ significantly in different regions.
Read more: Causes of inflation and scientific approaches to their study
Formula
The change in the price of an individual industrial product is estimated in relation to its price in the base period, calculated using the following formula:
PPIi = (Pt / PB) x 100%
PPIi – change in the value of the i-th industrial product;
Pt – the price of the i-th k of an industrial product at the end of the period t;
PB - the price of the i-th industrial product in the base period.
When calculating the producer price index, the specific weight of each of the goods is taken into account, so in general, the formula for calculating it can be represented as follows:
PPI = (SUMM (N; i=1) PPIi) x yi
N – the number of industrial goods included in the index;
yi is the specific weight of the i-th product.
Producer price index "at the entrance" and "at the exit"
When disclosing statistical information, data on the producer price index can be provided "at the input" (PPI Input) and "at the output" (PPI Output). The first of them takes into account changes in prices for raw materials, materials, components and semi-finished products. An increase in its value is not always an indicator of future inflation, since manufacturers can compensate for an increase in purchase prices by reducing other expenses, without increasing the selling prices for finished products.
In turn, PPI Output reflects the change in prices for goods and finished products and is one of the indicators of future inflation.
Read more: How to invest in stocks and what you need to know
Impact on the market
Investors primarily pay attention to how much the indicators have changed compared to the consensus forecasts of analysts, although long-term trends are also important.
Stocks
The reaction to the indicator depends on the stage of the economic cycle. In principle, a small inflation is a positive, as it encourages consumers to buy. To a limited extent, it is extremely important, especially when the economy is coming out of recession. Nevertheless, when the development of the national economy is gaining momentum, inflation can get out of control. The steady growth of the Producer Price Index noticeably above 2% year — on-year is already a reason to think (for the United States). Even more dangerous is the situation when the increase in inflationary pressure coincides with the stagnation of GDP. A steady and significant increase in PPI means an increase in production costs, which leads to a decrease in profits and a reduction in dividend payments. When inflation becomes a threat, the Fed can tighten monetary policy. That is why now, when the upcoming increase in interest rates is on the agenda, it is so important to monitor inflation indicators.
Read more: Features of successful Forex trading according to GDP data
Bonds
The players of the fixed income securities market carefully monitor the dynamics of the index. The logic of decision-making is simple, the higher the PPI, the worse it is for bonds, and the higher their yields. And vice versa.
The dollar exchange rate
As a rule, the US currency benefits from moderate inflation and a careful increase in Fed rates. However, too much inflation and the aggressive "hawkish" policy of the US Fed are dangerous for the economy and can weaken the dollar in the long term.
The strengths of the indicator
- The first important indicator that measures inflation.
- Intuitive.
Weaknesses of the indicator
- Volatility by month.
- The exclusion of food and energy prices should be used only in a limited way, since these costs still need to be taken into account when assessing inflation.
- Does not take into account the prices of services.
Read more: What is the Consumer price index CPI
Read more: What is the Industrial Production Index (IPI)
Read more: Purchasing Managers Index (PMI) - what is it and why an investor needs it
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Producer Price Index Business Definition
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