Moderation for services inflation, which has been stubbornly higher, helped cool producer price pressures in July in what should add incrementally to expectations for a September rate cut. Headline producer prices edged only 0.1 percent higher on the month in July versus Econoday's consensus for a 0.2 percent rise, while the year-over-year rate slowed to 2.2 percent which was well under expectations for 2.6 percent and down from a revised 2.7 percent in June. Services prices slowed from an annual 3.5 percent to 2.6 percent for the lowest rate of inflation since early this year. Goods prices remain subdued at 1.7 percent annually though this was up from 1.3 percent in June and the highest rate since March last year.

But indications from this report are solidly favorable, evident in ex-food ex-energy where the monthly rate came in unchanged for the lowest reading of the year while the annual rate slowed from 3.0 to 2.4 percent for the lowest since March this year.

Services prices declined across categories including for machinery and vehicle wholesaling which fell 4.1 percent on the month. Prices for food and alcohol retailing, software publishing and physician care also fell, offsetting a 2.3 percent rise for portfolio management services. A monthly 2.8 percent rise for gasoline lifted goods readings offsetting a 1.1 percent decline for electric power.

But the big report for inflation will be tomorrow's CPI where only mixed results are expected. Econoday's Relative Performance Index currently stands at minus 14 to indicate that recent US economic data are coming in slightly below expectations, which if extended to tomorrow's CPI would further boost rate-cut expectations.

Producer prices, which have been slowly climbing, are expected to rise 0.2 percent on the month in July to match June's increase. The annual rate in July is seen at 2.6 percent which would also match June's increase. July's ex-food ex-energy rate is seen up 0.2 percent on the month and up 3.0 percent on the year which would compare with respective gains of 0.4 and 3.0 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.