Producer prices fell again in December. A 1.2 percent monthly drop was fully three times the market consensus and the seventh decline in the last eight months. Annual PPI inflation eased from minus 7.9 percent to minus 8.6 percent although this was only a 2-month low.

Energy prices, which decreased 3.7 percent versus November, did most of the work but even excluding this category prices were only flat on the month, leaving the annual underlying rate steady at just 0.3 percent. Within this, intermediates, capital goods and consumer non-durables were all unchanged.

Today's update leaves a very weak trend in producer prices and so provides further evidence of the underlying weakness of the German manufacturing sector. It also reduces the German RPI to minus 28 and the RPI-P to minus 24. Both readings show economic activity in general continuing to lag market expectations.

After falling 0.5 percent on the month in November, December's PPI is seen falling 0.4 percent. Year-over-year, the PPI is expected to fall 7.9 percent to match November's contraction.

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.