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Economy in Brief

Summary of PPI and Diffusion Inflation Diffusion Year/Year From Yr Ago
The PPI surprised us with an unexpectedly strong headline jump of 1.3% and an accompanying core rate that rose by 0.4%. Neither was as expected, nor welcome.

I consider myself an inflation agnostic but I have run into quite a number of disinflation believers recently and not many inflation-fearers. So being an inflation agnostic is being at one end of the spectrum these days. Increasingly I have heard people wonder when the Fed will dismantle its bias and further ask when the Fed is going to start cutting interest rates…not ‘if’, but ‘when’. And may be that will prove to be the correct tact for policy. But for now the question seems to be much more up in the air. For now- at least until we see the Friday CPI- the question has become a live one.
Let’s begin to look at PPI inflation through the lens of a proprietary calculation I make using Haver data. I transform it as follows to form a measure of inflation diffusion: This calculation checks though all the PPI components assessing if inflation rose or fell in the recent Yr/Yr period compared to the Yr/Yr change of one year ago. From these comparisons we use logical operators to count the percentage of PPI components where inflation has accelerated, decelerated or remained the same. We group them and from these sums we construct ISM-like diffusion indexes. In that framework a value of 50 is neutral. Any value above 50 shows more underlying components are afflicted by inflation rising; below a value of 50 relatively more components are seeing inflation fall. The results for February 2007 are in the table below: 
Summary of PPI and Diffusion
  Inflation Diffusion
Year/Year From Yr Ago
Feb-07 Feb-06 Feb-07 Feb-06
PPI Total 2.5% 3.9% 51.9 39.0
PPI Core 1.8% 1.7% 54.1 42.9
Consumer Goods
  Consumer Foods 6.8% -1.0% 83.3 44.4
  Core Consumer 1.8% 1.7% 56.3 45.8
Capital Goods 2.2% 1.6% 52.0 44.0
The table above shows the inflation rate for Feb 2007 as well as for 2006 for the headline as well as some select components. It has a matching set of columns that display diffusion data for each of these breakdowns in each of the years. The table tells us that the inflation acceleration is for real. Even though headline inflation is lower in Feb 07 than in Feb 06, slightly more components in 2007 show a rising rate of inflation compared to 2006 (diffusion of 51.9). The core rate did accelerate in 2007 to 1.8% compared to 1.7% one year ago and its components also show relatively more inflation with a diffusion reading of elevated above 50 at 54.1. We know food inflation was high this year at 6.8% compared to -1% a year ago -- diffusion confirms that with a huge diffusion value of 83.3, implicitly saying that there may have been a few items where prices spiked but that inflation accelerated on a broad front, too. Food price inflation is very widespread. As for the part of the PPI that applies to consumer goods, the core consumer readings in the PPI show inflation up at a 1.8% pace compared to 1.7% a year ago and diffusion confirms the acceleration is widespread with a diffusion reading of 56.3. For capital goods the inflation acceleration to 2.2% from 1.6% a year ago corresponds to a mildly inflation-prone reading of 52 for diffusion. 

The diffusion approach I use does not weight components. The idea is that if we have inflation, it is by definition broad-based and should show up across components. If the monthly headline or core inflation spikes but diffusion remains below 50 we discern that one or ‘several’ components with relatively large weights saw prices rise, but that the rise was not widespread. In that case the impact on the price level probably reflected more an initial shift in relative prices than in inflation. This approach has the advantage of being objective each month and does require subtracting the biggest price surge or the largest drop to get a better gauge of what is going on with inflation. Diffusion is the gauge of what is going on. See chart below:
  Feb-07 Feb-06 Feb-07 Feb-06 PPI Total 2.5% 3.9% 51.9 39.0 PPI Core 1.8% 1.7% 54.1 42.9 Consumer Goods   Consumer Foods 6.8% -1.0% 83.3 44.4   Core Consumer 1.8% 1.7% 56.3 45.8 Capital Goods 2.2% 1.6% 52.0 44.0
Summary of PPI and Diffusion
  Inflation Diffusion
Year/Year From Yr Ago
Feb-07 Feb-06 Feb-07 Feb-06
PPI Total 2.5% 3.9% 51.9 39.0
PPI Core 1.8% 1.7% 54.1 42.9
Consumer Goods
  Consumer Foods 6.8% -1.0% 83.3 44.4
  Core Consumer 1.8% 1.7% 56.3 45.8
Capital Goods 2.2% 1.6% 52.0 44.0
Summary of PPI and Diffusion
  Inflation Diffusion
Year/Year From Yr Ago
Feb-07 Feb-06 Feb-07 Feb-06
PPI Total 2.5% 3.9% 51.9 39.0
PPI Core 1.8% 1.7% 54.1 42.9
Consumer Goods
  Consumer Foods 6.8% -1.0% 83.3 44.4
  Core Consumer 1.8% 1.7% 56.3 45.8
Capital Goods 2.2% 1.6% 52.0 44.0
The chart above shows you how diffusion tracks changes in core inflation. Note that the diffusion index generally changes a little before actual inflation trends do. Diffusion below 50 usually points to a falling inflation rate and above 50 the rate of inflation is usually rising. Current diffusion for core consumer goods at the PPI level shows inflation pressures are RISING. The period of downward pressure on inflation is over- at least for now. 

A conventional time series plot of the Core components of the PPI shows elevation in inflation spreads across most main PPI categories Core consumer nondurables, core consumer durables and capital goods. Consumer durables prices let off a bit of steam this month but the pace of inflation they carry is still high by recent standards. 


As we look ahead to the CPI we can look to the trends for consumer prices embedded in the PPI to see if CPI goods prices have inflation pressures. Core nondurable goods prices have growing pressures. Durable goods prices had growing pressures but those have subsided in the most recent three months. Remember that to these trends we add imports of consumer goods and all consumer services. The producer prices contribution to the core CPI is only about 30%. And as we consider adding import prices we saw in the import prices report that those pressures were not strong in February. For services we have little to go on. Price diffusion did ease off in the non-mfg ISM in February but it was still over 53 in value. Plus labor costs seem to be showing pressure while productivity is lagging. The inflation risks still seem to be on the upside to me, at least for now. At least I don’t think it’s a good time to assume that inflation is not a problem.
Energy Trends in the PPI
  Feb-07 Jan-07 Dec-06 3-mo 6-mo 12-mo
Residential Electric Power 1.1% 1.1% 0.3% 10.7% -7.6% 5.8%
Residential gas 1.7% -1.4% 0.9% 4.9% 12.8% -29.4%
Gasoline 5.1% -6.3% 1.4% -0.7% -69.2% 21.2%
Fuel Oil 4.9% -9.4% -1.0% -21.6% -53.6% 18.1%
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