Producer prices were higher than expected in January, reminding that the road to price stability remains challenging, although 12-month inflation rates did slow down from December. Just not as much as anticipated. PPI final demand rebounded 0.7 percent in January after declining a revised 0.2 percent in December, above Econoday's consensus estimate of 0.4 percent, which was also the highest forecast. The monthly gain was the largest since June 2022. On a 12-month basis, the overall inflation rate came down to 6.0 percent from 6.5 percent, the lowest since March 2021, but still exceeded the median forecast of 5.5 percent.

Food prices fell another 1.0 percent in January after retreating 0.9 percent in December, bringing the 12-month rate down to 11.6 percent from 14.3 percent, the smallest increase since October 2021. By contrast, energy prices recovered 5.0 percent in January after falling 6.7 percent in December and 2.2 percent in November. Energy prices rose 10.4 percent year-over-year after 9.2 percent in December. Prices excluding energy rose 0.4 percent month-over-month and 5.8 percent year-over-year.

Excluding food and energy, final demand PPI was up 0.5 percent on the month after 0.3 percent in December, and 5.4 percent year-over-year, above the 5.0 percent consensus estimate. When also excluding trade services, prices rose 0.6 percent on the month, the fastest pace since March 2022, while the 12-month rate declined to 4.5 percent from 4.7 percent, the lowest since March 2021.

Goods inflation was 1.2 percent on the month and 7.5 percent year-over-year. Services were up 0.4 percent and 5.0 percent, respectively. Both goods and services price gains slowed down year-over-year.

Today's data confirm the slowdown in the 12-month inflation pace, although the monthly readings call for vigilance, as they did for consumer prices, especially with Econoday's Consensus Divergence Index at 26, indicative of an economy that is performing appreciably better than expected.

Producer prices in January are expected to rise 0.4 percent on the month for a year-over-year increase of 5.5 percent that would compare with 6.2 percent in December. The annual core rate in January is also seen moderating, to 5.0 percent versus December's 5.5 percent.

The Producer Price Index (PPI) of the Bureau of Labor Statistics (BLS) is a family of indexes that measures the average change over time in the prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. Effective with the January 2014 PPI data release in February 2014, BLS transitioned from the Stage of Processing (SOP) to the Final Demand-Intermediate Demand (FD-ID) aggregation system. The headline PPI (for Final Demand) measures price changes for goods, services, and construction sold to final demand: personal consumption, capital investment, government purchases, and exports.

The PPI measures prices at the producer level before they are passed along to final consumers. A portion of the inflation at the producer level gets passed through to the consumer price index (CPI). By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months.

While the CPI is the price index with the most impact in setting interest rates, the PPI provides significant information earlier in the production process. As a starting point, interest rates have an"inflation premium" and components for risk factors. A lender will want the money paid back from a loan to at least have the same purchasing power as when loaned. The interest rate at a minimum equals the inflation rate to maintain purchasing power and this generally is based on the CPI. Changes in inflation lead to changes in interest rates and, in turn, in equity prices.

The PPI comes in two key main versions: final demand (FD) and intermediate demand (ID). The final demand portion is composed of six main price indexes: final demand goods; final demand trade services; final demand transportation and warehousing services; final demand services less trade, transportation, and warehousing; final demand construction; and overall final demand.

The intermediate demand portion of the FD-ID system tracks price changes for goods, services, and construction products sold to businesses as inputs to production, excluding capital investment. There are two parallel treatments of intermediate demand, each constructed from the identical set of commodity price indexes. The first treatment organizes commodities according to commodity type, and the second organizes commodities using a stage-based, production flow model.

The PPI is considered a precursor of both consumer price inflation and profits. If the prices paid to producers increase, businesses are faced with either charging higher prices or taking a cut in profits. The ability to pass along price increases depends on the strength and competitiveness of the marketplace.

Under the prior PPI system, the producer price index was substantially more volatile than the consumer price index because the CPI included services while the PPI did not. Volatility has been reduced substantially in the PPI-FD due to the inclusion of services but the PPI still is more volatile than the CPI. Wages are a bigger share of the costs at the retail level than at the producer level and this plays a role in the CPI’s lower volatility. Also, the PPI does not include owners’ equivalent rent—a large and slow moving component in the CPI. Food and energy prices are major sources of volatility in the PPI, hence, the greater focus on the"core PPI" which excludes these two components.

The bond market rallies when the PPI decreases or posts only small increases, but bond prices fall when the PPI posts larger-than-expected gains. The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.