Inflation expectations are an essential component of Forex trading. Central banks use inflation expectations around the globe to determine interest rate levels. Interest rates are the driving force behind the forward curves that are used in the Forex markets. When interest rate differentials change, they will help drive the future direction of a currency pair. There are several different types of inflation expectations. Inflation at the wholesale level is called producer price inflation. The most common index used to track producer price inflation is the producer price index.
What is the Producer Price Index?
The analysis of the producer price index (PPI) is a form of fundamental analysis. The PPI calculates inflation at the wholesale level by calculating the price of intermediate goods. Generally, the PPI provides you with price movements from the seller’s point of view before a good or service is consumed at its final destination. In other words, this index tracks change to the cost of production. For example, gasoline costs are made up of crude oil, plus the cost of refining, marketing, and shipping it to a gasoline station. Gasoline is then consumed by someone filling up their car, and the price would fall under consumer price inflation. The cost of crude oil would be used to calculate producer prices.
Who Produces the Producer Price Index?
Governments generally produce wholesale inflation indices. For example, in the United States, the Bureau of Labor Statistics calculated the Producer Price Index. This group is part of the Department of Labor. The Bureau of Labor Statistics uses 10,000 individual products to come up with its producer price index. The data includes information from sectors including construction, agriculture, manufacturing, technology and mining.
Different Levels of Producer Price Classifications
There are different levels of producer price classification used to produce the producer price index. For example, the cost of production at the industry level is called industry PPI. If a product is a commodity, such as a grain like corn, the price is ignored at the industry level and calculated as a commodity.
Why are Producer Prices Important?
Producer prices are important because they play a role in creating inflation or deflation. Inflation occurs when prices are rising, and deflation occurs when prices are falling. Central banks watch inflation and deflation to determine if they needed to increase or decrease interest rates. Individual central banks only evaluate inflation to determine if they need to alter inflation. The Federal Reserve has a dual mandate to monitor inflation as well as employment levels.
Producer price inflation is essential because it will often spill over into consumer prices and drive up the end user’s costs. For example, if the price of crude oil rises, it will impact the cost of gasoline. If the price of gas increases, it will create a cost for consumers who need to drive to work.
A central bank will be concerned with a spillover effect. When producer price inflation spills over into consumer prices, inflation can rise at a rate that is faster than consumers can afford. While some inflation is good, when inflation rises too quickly, it can erode future growth.
For example, if consumers are spending more of their income on gas, they will have less income to spend on discretionary produces, such as gifts. On the production side of things, if an industry is spending more money on transportation, they will have less money to invest in their business. While prices need to rise, an optimal rate will allow an economy to grow without contracting growth. The Federal Reserve, the central bank in the United States, believes that optimal growth is 2% year over year. When consumer inflation rises at a level above 2% year on year, the Federal Reserve will consider raising short-term interest rates.
If producer prices fall, they will eventually have an impact on consumer prices. If prices fall too quickly, a central bank will need to consider reducing interest rates to fend off deflation. If producer prices fall, lowering consumer prices will erode a company’s ability to be profitable and reduce its ability to hire employees.
When Are Producer Prices Reported?
Countries around the globe will produce their producer price indices once a month. You can track the release of a producer price index through an economic calendar. The producer price index can be found in financial news articles as well as on government websites.
How are Produce Prices Reported?
Producer prices are usually reported on a month over month basis and a year over year basis. Month over month producer prices tells you how month prices at the producer level have changed relative to the last month. Year on year, producer price chances tell you how much prices have changed relative to the same period a year ago.
What Can Happen to a Forex Pair After The Release of a PPI Report?
The key to the producer price index is whether it is in line with expectations. If a producer price index is larger than expected, it can push interest rates higher and increase currency value. For example, if European PPI is more robust than expected, the result could be a stronger Euro. Alternatively, if a producer price index is weaker than expected, it can drive an exchange rate lower. For example, if US PPI is more fragile than expected, the dollar could decline.
The Bottom Line
The PPI index is a crucial gauge of wholesale inflation. Wholesale inflation is significant because it can spill over into consumer inflation and erode spending. Higher levels of producer inflation can also reduce a business’s ability to invest in their company. The government calculates the producer price index. For example, in the United States, the Department of Labor produces the Produce Price Index. The producer price index is reported on a month over month and a year over year basis. The PPI index is a crucial driver of interest rates. Higher or lower rates can have an impact on a currency pair. The PPI index is generally released once a month and can be found through a financial news portal or a government website.