PPI is a major economic data due to its signaling effect on future expected inflation. It reflects the change in the cost of products sold by various manufacturers and industries. It is therefore a precursor to underlying inflation and is closely watched by traders.  Forex Traders monitor PPI for the positive relationship between interest rates and inflation, but ultimately, traders are concerned with how the resultant interest rate changes are likely to affect currency pairs.

So let’s take a look at the “PPI Index” aspect of these reports to see how they are interpreted in the foreign exchange market.

What is PPI?

Who produces PPI?

Governments generally produce wholesale inflation indices. For example, in the United States, the Bureau of Labor Statistics calculate the Producer Price Index. This group is part of the Department of Labor. The Bureau of Labor Statistics uses 10,000 individual products to come up with its producer price index. The data includes information from sectors including construction, agriculture, manufacturing, technology and mining.

How PPI is measured

• First Stage – The Commodity Index, which tracks the price fluctuations from month to month for commodities such as crude oil and coal.
• Second Stage – The Processing Index, which tracks the prices that are paid for goods sold to manufacturers that will then add value by producing finished products.
• Third Stage – The Industry Stage, which is the measurement of manufacturing output.

Why PPI is important

• Inflation is probably the second most watched indicator after unemployment data, as it helps investors deduce the future direction of monetary policy. The core PPI can serve multiple roles in improving the investment-making decision because it can serve as a leading indicator for CPI. When producers are faced with input inflation, those rising costs are passed along to the retailers and eventually to the consumer.
• PPI presents the inflation picture from a different perspective than CPI. Although changes in consumer prices are important for consumers, tracking PPI allows one to determine the cause of the changes in CPI. If, for example, CPI increases at a much faster rate than PPI, such a situation could indicate that factors other than inflation may be causing retailers to increase their prices. However, if CPI and PPI increase in tandem, retailers may be simply attempting to maintain their operating margins.
• The producer price index can identify various price alterations and changes before the goods enter the marketplace. Therefore, the PPI comes in considerably handy for the government to formulate adequate fiscal and monetary policies.

What Can Happen to a Forex Pair After The Release of a PPI Report?

The key to the producer price index is whether it is in line with expectations. If a producer price index is larger than expected, it can push interest rates higher and increase currency value. For example, if European PPI is more robust than expected, the result could be a stronger Euro. Alternatively, if a producer price index is weaker than expected, it can drive an exchange rate lower. For example, if US PPI is more fragile than expected, the dollar could decline.

Conclusion:

The PPI index is a crucial gauge of wholesale inflation. Wholesale inflation is significant because it can spill over into consumer inflation and erode spending. Thus, the most valuable component of the PPI data is the signaling effect it provides to the market. In the foreign exchange market, traders are very concerned about the index. If the producer price index is higher than expected, there is the possibility of inflation. The central bank may implement a tightening monetary policy, which has a positive impact on the country’s currency; if the producer price index falls, it will have the opposite effect. The PPI index is generally released once a month and can be found through our Winstone Prime Economic Calender.