According to the US Bureau of Labor Statistics, the Producer Price Index (PPI) is “a family of indexes that measures the average change over time in the selling prices received by domestic producers of goods and services." But outside these technical and pretentious words, there are some fascinating facts about this macro-economic term.
The PPI explained
The Federal government releases monthly economic reports, offering investors a glimpse into the market conditions that could potentially impact stocks of companies, the currency market, and other financial sectors.
One of these essential reports is the PPI. This family of indexes tracks the movement in producer prices for many industries in the goods-producing sectors of the American economy: agriculture, manufacturing, mining, gas, electricity, construction, to name just a few. Generally, the industries analyzed are those of mass consumption goods (40%), food (26%), industrial (25%), and energy (9%). Overall, the Producer Price Index covers about 72% of the service sector's output.
The Producer Price Index includes three different indexes, reflecting an accurate measurement for different stages of production:
● PPI Commodity Index (crude index): tracks the average price change for raw materials such as coal, crude oil, and other commodities.
● Stage of Production Index (SOP index): measures any change in prices that manufacturers pay for goods that are sold to them that will add value to produce finished products - lumber, diesel fuel, steel, and others.
● *Industry Index (Finished Goods index): accounts only for the goods that are in the final stage of production
*The industry index is the foundation for the core PPI, the most important PPI indicator. It takes the figures from the Industry Index and removes the food and energy sectors, as these are usually very volatile.
Also, investors closely monitor the percentage changes from the previous month and the annual projected rate of the PPI.
How is the Producer Price Index calculated?
People calculate the Producer Price Index using the following formula: PPI = current price of a basket of goods/base price of the basket of goods.
Movements in the PPI value are measured from a base period perspective when the index is set to 100. Currently, some PPIs have an index base set at 1982 = 100, and others have a base that corresponds with the month before the month that the index was introduced.
Let’s take an example: an index level of 105 means there has been a 5% increase in prices since the base period. An index level of 95 means prices have gone down 5%.
Another thing you should keep in mind: the PPI only measures prices that producers pay during the period of each survey. So, if a company signs a long-term contract with a customer, it may have a higher or lower negotiated price that won’t be accounted for until a future date.
Who’s in charge of reporting an official Producer Price Index?
The Bureau of Labor Statistics - a part of the Department of Labor - gathers all the information and issues each report in the second week of the month, reflecting the previous month's numbers. Also, the Bureau releases final figures for the indexes published four months earlier.
The Producer Price Index can be issued for other countries, such as the United Kingdom (UK Producer Price Index) or the Eurozone Producer Price Index.
PPI and inflation
The Producer Price Index is a leading economic indicator because it can predict inflation. The connection is straightforward: when producer prices go up, the consumer will also feel the effects. Any movement to prices in the PPI won’t instantly reflect in the economy when the report goes out, but it could indicate that changes could come.
Higher inflation levels can affect interest rates, impacting the companies' investment decisions and their stocks. Lower inflation levels can lead to higher consumer demand and higher profits and share prices.
Producer Price Index (PPI) vs. Consumer Price Index (CPI) – the connection
The PPI is different from the CPI because it measures costs from producers’ viewpoint, and not from the perspective of consumers.
The Producer Price Index of finished goods is an excellent indicator for the Consumer Price Index, as every price change at the retail level transfers to consumers when they buy those goods. And since the CPI is a barometer for measuring inflation, the PPI works as a preview for it.
How to use the PPI in your day-to-day trading?
If PPI increases, interest rates are likely to grow, too, making saving money more attractive. Spending money is less attractive, as consumers would lose money on the higher interest rate. As a direct consequence, increased PPI levels may help the currency markets get stronger.
So, after checking the PPI readings, you should know how to interpret the data and put it into trades. For instance, if we’re talking about the CPI for the US Economy, the direct influence will be over the CFDs for EUR/USD, S&P500, DOW JONES, NASDAQ, or even commodities strongly tied to the US Dollars such as CRUDE OIL, GOLD, or SILVER.
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Users/readers should not rely solely on the information presented herewith and should do their own research/analysis by also reading the actual underlying research. The content herewith is generic and does not take into consideration individual personal circumstances, investment experience or current financial situation.
Therefore, Key Way Investments Ltd shall not accept any responsibility for any losses of traders due to the use and the content of the information presented herein. Past performance is not a reliable indicator of future results.