Could the primary market measure of inflation switch from the Consumer Price Index (CPI) to the Producer Price Index (PPI)?  According to recent research from Citi, the answer is a resounding “yes.”

Revised “producer” statistics includes consumer data

The Bureau of Labor Statistics (BLS) will post a revamped PPI next week, the research note observed. This revised measure of “producer” inflation will capture a much broader sampling of prices received by US businesses by encapsulating prices associated with items produced for government and exports – as well as for consumers and capital spending.  It’s the last part of that sentence that is most interesting.

“As a result of the new more comprehensive PPI resemble the consumer price index CPI at the same time it will be its own alternative measure of economic wide inflation,” the report’s authors Peter D’Antonio and Dana Peterson said. “As such we think the new PPI release will increasingly become a market focus, especially since it was released before CPI each month.”

PPI complete overhaul

The shift to the new PPI is a complete overhaul in terms of coverage, concept, and presentation, the report notes. Most of the added prices are of services, which had not previously been included, and also construction prices are added.  “The idea is to create an index that fully represents prices that businesses receive throughout the entire economy,” the report said. “Consequently, the new series will look nothing like the old one.” Market participants who were fans of the old PPI can still find it imbedded in the details of the new report.  The old PPI has just a weight of just 24% in the new index.

The addition of service prices alters character of headline PPI readings in two important ways, the report notes.  First, month-to-month volatility will be much more subdued, the report projects.  Second, the measured trend inflation rate could differ greatly. Comparing the three years of history provided by the BLS, the standard deviation of monthly changes in the new series was just 0.2 versus 0.5 for the old series.

PPI

PPI

“The lower volatility of the new series can be attributed to the 64% weight of services, which by their nature show much more muted price swings (Figure 1). In addition, the outsize weight of services prices will tend to dampen the wide swings in goods prices – yielding more stable overall inflation readings (Figure 2).”

“The inclusion of services makes the new PPI a far superior measure of the types of costs that will ultimately pass to consumers in the CPI,” the report observes.  “The personal consumption PPI sub-index – a new gauge that includes goods and services but excludes prices for items not consumed by households – is even closer in definition to the CPI (Figure 3). The old PPI measure that dominated the tapes for decades included costs for capital investment. Moreover, its restriction to goods only accounted for a third of items that households purchase.”