Producer Price Index (PPI) serves to measure the difference in the price of final products and services sold by its manufacturers.
The index reflects the difference in the average price of a basket of goods bought by producers on a monthly basis.
How is PPI Calculated?
PPI tracks commodity-based, industrial-based, and stage-of-processing-based companies. The U.S. Bureau of Labor Statistics developed the index using data accumulated from a mailed survey of retailers selected based on the systematic sampling of all companies listed under the Unemployment Insurance System.
The PPI value is displayed as a percentage difference on a year-to-year or month-to-month basis. If the difference expressed in the PPI index is positive it means that the expenses are growing and ultimately the price rises get handed down to consumers.
If it’s a large-scale effect, it is likely that there will be an increase in future CPI numbers which indicates that the general level of prices has risen. A surging general price level is usually a good sign but only for an economy that is controlled. In other words, when demand for products and services rises, companies have to increase capital spending and recruit more staff so that they can satisfy higher demand.
An increase in the general price level is good for an economy but only when this is contained. When demand for goods and services increases, businesses must increase capital expenditure and hire more workers in order to increase their output to meet higher demand.
However, if prices rise dramatically, it usually results in a deprecation in the purchasing power of the national currency. Simply put, $10 can buy less than it could before.
PPI’s Impact on Interest Rates
An increase in PPI can result in an increase in interest rates as well. In theory, when interest rates rise, people prefer to save money since the interest is bigger than before and spending money becomes more expensive. Therefore a higher PPI may indicate higher rates and a stronger currency.
For example, in Europe, an increase in interest rates results in higher financial flows from international investors who wish to purchase the high-yield Euro. As a result, the EUR rises in value due to increased demand.
During the periods of high-interest rates, investors like to use the so-called carry trade strategy where they borrow funds in a low-interest rate currency and use it to buy a high-interest-rate currency.
Money goes after yield this is something that investors try to benefit from. PPI doesn’t substantially affect the U.S. dollar initially. The reason for this is because in the economy where there’s a delay between the rise in prices from producers and because of higher inflation arising from consumers having to pay out more at the tills.
In conclusion, PPI represents significant economic data which traders use as a fundamental indicator of future expected inflation. Forex traders keep an eye on PPI due to the positive relationship between inflation and interest rates, but before anything else, traders are interested in how will the final interest rate changes impact the currencies.
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