What is the producer price index and how is it calculated
The Producer Price Index (PPI, in the English version Producer Price Index, PPI) reflects the change in prices for goods produced by enterprises of the country during their wholesale sale. In fact, the indicator gives a picture of changes in wholesale prices on the side of the primary seller (manufacturer). This is what distinguishes it from another important index – consumer prices (CPI, CPI), which is formed by the price of the goods on the buyer's side.
For your information! In the USA, until 1978, the indicator was called the Wholesale Price Index (WPI, wholesale price index).
For a complete presentation of the information, a representative sample of products from national manufacturers is taken:
By production stages: raw materials, intermediate and final products.
Industries: all the most important industries and the agricultural sector for the country's economy are included.
Assortment: the index includes all the main product groups produced in the country, for each of which one or more representative products are selected. The latter are characteristic types reflecting the general properties of the products of the commodity group, its consumer qualities and price dynamics.
Important! The producer price index does not include products of the service sector and goods supplied to the country by foreign manufacturers. This determines its important differences from CPI and more pronounced dynamics.
The calculation is carried out according to the ratio
n is the number of products in the index structure;
Qi is the weighting factor for each type of product;
Cci and Cbi – respectively, the prices of each type of goods in the current (reporting) and base periods.
The weighting factors for the index items are determined in such a way as to accurately reflect the structure of production in the country.
Like any other price index, PPI allows you to track the dynamics of inflationary processes. At the same time, national banks of states consider lower target values for it than for CPI. So in the USA and the European Union, PPI at the level of 2% is considered acceptable.
Features of the Producer Price Index in the USA and Russia
Despite the general approach to the methodology, the calculation of the Producer Price Index in different countries has its own peculiarities.
So, in the USA, they define and publish:
Input PPI (PPI "at the entrance") – the value of the index for raw material prices.
Output PPI (PPI "at the output") is an index of prices for finished products.
Core PPI (basic PPI) is an index excluding food and electricity prices that are most sensitive to seasonal fluctuations.
In Russia, Rosstat calculates several price indices:
Industrial production. It was he who received the name PPI and plays the same role as PPI in the USA.
Agricultural production.
Prices in construction.
Not only the integral index of industrial production prices is published. In addition, a breakdown by type of economic activity is available (in accordance with the KVED classifier), as well as by goods and commodity groups.
The role of PPI in investing
The producer price index is considered to be the leading indicator in calculating inflation. This is due to the fact that the increase/ decrease in these prices, as a rule, is appropriately reflected in retail prices (which CPI takes into account). However, this effect does not affect immediately, but with a delay of several weeks to 2-3 months.
Another important feature of it is a clear indication of the source of inflationary pressure. At the same time, economists believe that the growth of production costs (namely, PPI shows them as accurately as possible) affects the economy as a whole much more strongly than demand inflation associated with monetary factors or consumer expectations.
Thus, investors monitoring the producer price index receive an earlier signal of a potential increase in inflation. In addition, it is stronger than the CPI (especially in annual terms), and allows you to predict the response of the monetary authorities with greater probability.
However, this is true with some reservations:
1. The growth of PPI in the early production stages (raw and intermediate) does not necessarily cause an increase in prices for finished products. Manufacturers can compensate for this by reducing costs for other items or using more advanced technologies.
2. The growth of the index for finished products does not always translate into an increase in consumer prices (CPI). For example, retail chains can prevent this, again by reducing costs for other items.
3. Even if the dynamics of PPI is reflected in the behavior of CPI, this dependence is far from linear. The consumer price index includes services and imported goods in the calculation, due to the price dynamics of which the rise in price on the part of the national producer can be fully compensated.
As a result, it is difficult to call the reaction of the markets to the monthly publication of PPI unambiguous. Moreover, their sensitivity to changes in the indicator is usually low, especially in a stable economic situation. Nevertheless, the output of data significantly different from the forecast values may cause a significant increase in volatility.
In the foreign exchange market, a moderate increase in PPI within the target level, as a rule, causes the strengthening of the national currency. This is due to the predictability of decision-making by national banks in the long term.
In the bond market, both the prices of securities and their yields react to significant deviations of the index. With an increase in PPI, prices decrease, and profitability, respectively, increases. At the same time, the reaction of corporate issues is much more pronounced than that of state ones.
In the stock market, the reaction is usually ambiguous and poorly expressed. To a large extent, it is caused not only by the absolute dynamics of the index, but also by the magnitude of its deviations from the forecast values.
Investors who prefer stocks to other exchange-traded instruments should pay attention to several standard situations:
Stable changes within the target level are considered as an incentive for the growth of the economy and, accordingly, the stock market. However, the publication of such data is most often completely ignored by securities quotations.
Significant deviations in annual terms (YoY) from the target level and forecast values look much more dangerous. Such growth indicates a serious increase in production costs, which may cause a decrease in company profits and the amount of dividends. The market shows a bearish attitude in response.
If, with an increase in the index in the price of finished products in PPI, there is no significant influence of raw materials and intermediate components, then there is an increase in prices due to an increase in demand. This option is considered a positive factor for the development of business and the economy as a whole and causes a bullish market reaction.
Important note! The unusually high dynamics of the index can provoke a quick reaction of national banks in the form of lowering or raising base rates, which will naturally affect all financial markets.