Producer prices fell sharply and by more than expected in July. A 1.1 percent monthly drop was much steeper than the market consensus and, with base effects strongly negative, reduced annual inflation rate from minus 0.3 percent to minus 6.0 percent.

Energy prices declined a sizeable 2.5 percent versus June and were off fully 19.3 percent from a year ago. However, even excluding this category the PPI fell a further 0.4 percent on the month, trimming its yearly rate from 2.8 percent to 2.0 percent. Elsewhere, the other main area of weakness was again intermediates where prices were down a monthly 1.0 percent. By contrast, both durable and non-durable consumer goods saw no change while capital goods were up 0.3 percent.

The latest decline in core producer confirms a clear downward trend in underlying pipeline inflation pressures in German manufacturing. However, significantly lower CPI inflation will need softer prices in services which, to date, remain much stickier. More generally, the July report puts the German ECDI at minus 2 and the ECDI-P at 8, both measures being close enough to zero to indicate overall economic activity performing broadly in line with market expectations.

After June's subdued 0.1 percent monthly increase, July's PPI is seen falling 0.1 percent. Year-over-year, the PPI has cooled for nine consecutive months and is seen falling in July to minus 5.0 percent from minus 0.3 percent.

The Producer Price Index (PPI) measures the price of industrial and commercial goods produced and sold domestically (excluding turnover tax). About 1,250 types of goods are used to calculate the index and prices are reported by a total of 5,000 enterprises under fixed contractual conditions. Changes in the index provide a guide to inflation from the point of view of the product's producer/manufacturer and, in contrast to the consumer price index (CPI), excludes VAT and other deductible taxed associated with turnover.

The PPI measures prices at the producer level before they are passed along to consumers. Since the producer price index measures prices of consumer goods and capital equipment, a portion of the inflation at the producer level gets passed through to the consumer price index (CPI).

Because the index of producer prices measures price changes at an early stage in the economic process, it can serve as an indicator of future inflation trends. The producer price index and its sub-indexes are often used in business contracts for the adjustment of recurring payments. They also are used to deflate other values of economic statistics like the production index. It should be noted that the PPI excludes construction. These price statistics cover both the sales of industrial products to domestic buyers at different stages in the economic process and the sales between industrial enterprises.

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

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.