The Producer Price Index or PPI is an important element in fundamental analysis and can affect exchange rates significantly when released. Producer Price Indexes are released for most of the countries in the major forex currency pairs, although the U.S PPI number is the release with the most influence on the forex market because of its impact on the U.S. Dollar that affects all major currency pairs.
The U.S. Producer Price Index is typically released by the U.S. Bureau of Labor Statistics two weeks after the end of the month the data has been compiled for. The number reflects the average change over time of the prices that domestic U.S. producers have received for their output. PPI is also widely used as a gauge for inflation, although it usually has more of an impact on the fundamental analysis of investors than on forex traders.
The Producer Price Index is similar to the Consumer Price Index or CPI, except that the PPI looks at the change of the price of goods produced from the perspective of the producer, not from that of the consumer.
What is the Producer Price Index?
The Producer Price Index or PPI is an important indicator of future inflation experienced by consumers. A rise in this number reflects when producers successfully charge more for their goods and services, thereby reflecting increased demand for their output and/or the passage of higher input costs on to consumers.
As an economic indicator, the PPI measures the difference in the selling price producers charge for their products. Prices are measured from when the order for the product was booked and not from when the product leaves the factory, making it a cost factor for buyers and an output aspect for sellers.
The PPI number is considered a leading indicator of consumer inflation when it is released before the Consumer Price Index or CPI, which is another key inflation number that has significant correlation to the PPI.
Measuring the Producer Price Index
The PPI indicator is derived from three separate measures based on the different stages of processing. The index can be applied to the finished, intermediate and crude stages of manufacturing. Although the forex market largely focuses on the core index, the following three PPI indices are released each month:
The PPI Commodity Index – measures the change in price of crude or unprocessed goods.
The PPI Stage of Processing Index – measures changes in the price of goods at the intermediate stage of production.
The Core PPI Index - measures changes in the prices of finished goods.
The base year for PPI calculations is 1982, which is given an index value of 100. The index for each month is then calculated on a weighted average basis, with each of the 1,000 products in the index assigned a specific weight. The weights are determined by the product’s relative share of total output in the economy, with the cumulative weight of all products equal to 100 percent.
How PPI Affects the Forex Market
A historical analysis of forex rates shows that the PPI numbers typically have a secondary effect on forex trading. The PPI number is used by some forex traders in their fx analysis as a preview to the CPI data, which usually has a more significant impact on currency trading. As an inflation indicator, the PPI number can signal inflationary tendencies early, which can be useful for trading forex over the longer term.
Healthy economies usually have a relatively low and stable rate of inflation. Although a high level of inflation reduces a consumer’s purchasing power, it is also a signal for a central bank to raise interest rates, which generally translates into a stronger currency.
On the other hand, a deflationary environment signals an overall weakening economy, which can be discerned by a falling PPI number. This situation can have a negative effect on that country’s currency as benchmark interest rates would be expected to fall to help stimulate the economy.