April's Producer Price Decline Confirms Low-Inflation Conditions

April's producer price index report provided a snapshot of both business conditions and prices as the U.S. economy pulls out of the long recession: Modest rising demand, with little impact on prices. Producer prices -- prices at the wholesale level -- fell 0.1% last month, with the core rate, which excludes food and energy, rising just 0.2%, according to U.S. Labor Department data.

Further, the above price pattern is typically what one would see from an economy that's recovering gradually, with a hodgepodge of sectors rebounding at various speeds. Some sectors are seeing modest inflation, others no inflation, and even price decreases.

Focus on Core Producer Prices

What's more, the April producer price index also offers a classic example of why the U.S. Federal Reserve concentrates on the core-PPI statistic. Prices for food and energy fluctuate, with price swings often driven by hard-to-predict factors -- the weather, Americans' vacation patterns and OPEC production decisions, among others.

Here's one example: In the past four months, energy prices rose 5.7%, fell 2.9%, rose 0.7% and declined 0.8%, respectively, in January thru April. Food prices have been slightly more stable. During the same period they rose 0.3%, 0.4% and 2.4%, then fell 0.2%.

Core PPI: A More Telling Statistic

Hence, because food and energy prices are hard to predict and sometimes rise or fall for the most arbitrary of reasons, the Fed emphasizes the core PPI rate. That rate is more likely to reflect enduring price power or price pressure that manufacturers and other businesses are experiencing.

In other words, by concentrating on core PPI, the Fed is asking, "What's happening to the cost of goods and services, excluding factors that businesses can't possibly control?" To be sure, the link between producer prices and consumer prices isn't perfect, but investors should know that the Fed is trying to gauge enduring demand and its impact on prices, and exclude demand that disappears in a month or a season.

And by that measure, inflation at the producer level remains tame. True, the top-line producer price index is up 5.5% in the past 12 months, but if you strip away that notoriously volatile food and energy component, producer prices are up just 1% in the past year.

Not Much Inflation -- How About Deflation?

Meanwhile, core consumer prices are up just 1.1% in the past 12 months, and taken together, the core producer and consumer price levels indicate that the U.S. economy -- despite the record fiscal stimulus package and unprecedented Fed quantitative easing -- isn't experiencing much inflation.

In fact, given current demand trends, the greater risk remains deflation -- a period of sustained price declines that robs companies of revenue, and that can lead to a recession, or even worse economic conditions.

And the producer price outlook moving forward? As of now, with little wage pressure, and no sign of robust demand, some price categories may remain under pressure, but a period of continued, low inflation is the likely price scenario. At minimum, the current producer price index trend will enable the Fed to maintain its so-called "extended period" low-interest rate monetary policy to stimulate the economy. At this juncture, rising inflation just isn't a threat.