Producer prices plunge in July on lower energy costs

Producer prices plummeted 0.9 percent in July, the U.S. Labor Department announced Tuesday, as energy costs retreated and slack demand pressured prices. The bottom line regarding the producer price index? Inflation is non-existent at the wholesale level. In fact, deflation remains a real risk in the quarters ahead.

Economists surveyed by Bloomberg News had expected producer prices to decrease 0.3 percent in July. Producer prices rose 1.8 percent in June and 0.2 in May.

Full-year PPI: little price pressure

Further, the tame inflation at the producer price level is evidenced by the 12-month PPI rate: producer prices have fallen 6.8 percent in the past year.

Meanwhile, in June the core PPI rate, which excludes the often-volatile food and energy component, fell 0.1 percent, compared to the Bloomberg News consensus estimate of a 0.1 percent rise. The core rate rose 0.5 percent in June.

Further, the 12-month core rate also is indicative of modest demand conditions, having risen just 2.6 percent in the past year.

Business executives, economists, and in particular Fed officials closely monitor the producer price index because it provides an early-stage warning regarding inflation. Fed officials pay especially close attention to the core-PPI statistic, which excludes the often-volatile food and energy component, to gauge core business costs.

In July, energy prices fell 2.4 percent, food prices declined 1.5 percent, finished consumer goods prices fell 2.4 percent, intermediate goods prices dropped 0.2 percent, construction prices fell 0.3 percent, and durable goods prices rose 0.6 percent.

Economic Analysis: The important statistic in the July PPI data is the core rate, a 0.1 percent decline. The headline 0.9 percent PPI decline was skewed lower by a sharp drop in energy prices, so investors should not assume prices are falling at that rate. Nevertheless, the lack of pricing power in the economy is clear: producer prices have plunged nearly seven percent in the past year, indicating that a lack of demand and a slack labor market has eliminated corporate pricing power and wage pressure.

The upside to this is the Fed will be able to continue its interest rate and quantitative easing policy into next year to stimulate the U.S. economy without fear of inflation.

The downside? Deflation remains a real risk for the economy. Deflation -- a protracted, systematic decline in prices and wages -- occurs in pronounced recessions and other conditions where demand is non-existent, it robs companies of the ability to increase revenue and hurts the economy's ability to grow. If it takes hold, that's another hurdle the Fed and policy makers will have to grapple with as they attempt to end the U.S. recession.

Based on July's PPI data, the Fed will likely keep short-term interest rates low for at least the next two quarters, and probably for longer, until the economy shows signs of sustainable, increased demand.
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