Producer Price Index Dips Again as Energy and Food Costs Fall

There was good news and bad news to be found in May's producer price report: The good news is inflation at the wholesale level remains tame, falling 0.3%, with the core rate, which excludes food and energy, rising 0.2%. The bad news is that the low inflation figure derived largely from lower energy prices, which tumbled on fears that Europe's debt woes will slow the global economic recovery.

Producer prices have now fallen in three of the past four months, with April and February posting declines of 0.1% and 0.3%, respectively sandwiched around a 0.7% rise in March.

Over the last 12 months, producer prices are up 5.3%, but subtract the food and energy segments, and the core rate is up just 1.3% for the past year. That's higher than the 1% 12-month core rate recorded in April, but it's still indicative of low inflation at the wholesale level.

Scant Pricing Power in the U.S.

It's easy to see which factor pushed the producer price index lower in May: gasoline prices, which plunged 7%. After trending higher for much of the year, prices for crude oil fell in late spring on the European debt concerns. In addition, prices for vegetables plummeted 18% in May, and overall food costs fell 0.6%.

That volatility in food and energy prices is a major reason the Fed emphasizes the core PPI rate, which is more likely to reflect the enduring pricing power or the price pressure that manufacturers and other businesses are experiencing. And right now, the core rate is signaling there's little pricing power in the U.S. economy.

Also in May, prices for finished consumer goods declined 0.5%, nondurable goods fell 0.7% and durable goods rose 0.3%.

May's producer price report confirmed subdued inflation at the producer level -- a price level that may be slightly too subdued for the Fed's tastes. That's because although there's always the risk of a sudden surge in prices due to a jump in oil prices, on balance deflation remains the greater risk to the economy, particularly if Europe's economy slows considerably.

Deflation -- a period of sustained price declines -- robs companies of revenue and can lead to a recession, which is obviously a scenario the Fed would take considerable pains to prevent.