Producer prices were lower than expected in December, when the headline index unexpectedly contracted another 0.1 percent on the month, marking the third decline in a raw following a downward revision to November's estimate. The index increased 1.0 percent year-over-year, below the 1.3 percent consensus forecast in an Econoday survey, but picking up from 0.8 percent the previous month.

Excluding food and energy, prices were also lower than anticipated, with the index remaining unchanged for the third consecutive month, and rising 1.8 percent from a year earlier. The core index, which also excludes trade services, was up 0.2 percent on the month, as expected, for a 12-month gain of 2.5 percent, up from a downwardly revised estimate of 2.4 percent in November.

While the headline data bring some relief following the higher-than-expected consumer prices, it was mostly due to food and energy. Instead, the core index, excluding food, energy and trade services, indicated a pick-up in inflationary pressures. It remains to be seen whether and to which extent this will be passed on to the retail sector. That being said, this latest uptick is not enough to question the downward trend since the 7.1 percent peak reached in March 2022. At the retail level, while the core index, excluding food and energy, was higher than expected, it slowed down to 3.9 percent, its lowest rate since May 2021.

In December, PPI for final demand, foods fell 0.9 percent on the month and 5.0 percent year-over-year. Energy was down 1.2 percent on the month and 4.8 percent on the year.

Prices for final demand goods contracted 0.4 percent, after declines of 0.3 percent in November and 1.4 percent in October. Goods prices fell 0.8 percent year-over-year. Services were flat for the third consecutive month, and rose 1.8 percent year-over-year, the smallest gain since January 2021, when it was also up 1.8 percent.

Producer prices in December are expected to rise 0.2 percent on the month versus no change in November. The annual rate in December is seen at 1.3 percent versus November's 0.9 percent increase. December's ex-food ex-energy rate is also seen at 0.2 percent on the month and at 2.0 percent on the year.

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.