US producer prices unexpectedly decline, signalling potential Fed rate cuts

US producer prices fall: US producer prices experienced an unexpected fall in December, marked by decreasing costs for goods like diesel fuel and food. The report from the Labour Department on Friday hinted at a continued decline in inflation, providing room for the Federal Reserve to contemplate interest rate cuts in the coming months.

The Producer Price Index (PPI) for final demand dipped by 0.1 per cent last month, as reported by the Labour Department's Bureau of Labour Statistics. Additionally, the data for November was revised, revealing a 0.1 per cent decline instead of being previously reported as unchanged. This marks the third consecutive monthly decline in the PPI.

Goods prices drop

Goods prices took a hit, dropping by 0.4 per cent, with a significant 12.4 per cent decline in the cost of diesel fuel contributing to half of this decrease. Excluding food and energy, goods prices remained unchanged after a slight uptick of 0.1 per cent in November.

The weakness in goods prices suggests that deflationary pressures persist, despite a temporary increase in consumer goods prices in December following two consecutive monthly decreases. Food prices, in particular, slipped by 0.9 per cent, with the cost of eggs witnessing a notable 20.5 per cent decline. However, this only partially reversed the significant 71.2 per cent surge in November, attributed to an avian flu outbreak.

In the 12 months through December, the PPI increased by 1.0 per cent, following a November advance of 0.8 per cent. Thursday's data revealed that consumer prices exceeded expectations in December, primarily driven by solid gains in shelter and healthcare costs.

Fed rate cut soon?

The unexpected decline in producer prices aligns with market expectations that the Federal Reserve might consider cutting interest rates in the coming months. While financial markets anticipate a potential rate cut in March, economists lean towards May or June, considering the resilience of the labour market. The Federal Reserve has raised its policy rate by 525 basis points to the current 5.25 per cent-5.50 per cent range since March 2022.

Services prices, however, remained unchanged, with declines in margins for machinery and motor vehicle wholesaling. Despite this, portfolio management fees saw a rebound of 1.5 per cent, reflecting recent stock market gains. Airline fares increased by 2.1 per cent, and health and medical insurance costs edged up by 0.1 per cent.

The overall situation, including the unexpected decline in producer prices and the persistence of subdued inflation, keeps the Federal Reserve's focus on price measures for its 2 per cent inflation target. As supply chains normalise after COVID-19 disruptions, services, particularly driven by a tight Labour market, play a crucial role in the ongoing battle against inflation.

Economists estimate that the Personal Consumption Expenditures (PCE) price index, excluding food and energy, rose by 0.2 per cent in December after a 0.1 per cent gain in November and October. The core PCE price is expected to increase by 3.0 per cent year-on-year, the smallest gain since March 2021, following a 3.2 per cent rise in November.

While geopolitical risks, such as the Middle East conflict and attacks on container ships, pose potential upside risks to inflation, increased oil production in the US is expected to counterbalance these impacts. The Producer Price Index, excluding food, energy, and trade services components, rose by 0.2 per cent in December, with the core PPI increasing by 2.5 per cent year-on-year.

"The key upside risk to inflation is from the war in the Middle East and potential disruptions to trade flows and global energy supplies," noted Bill Adams, Chief Economist at Comerica Bank in Dallas. "But petroleum and renewables output is growing faster than GDP in the US, which so far has offset the impact of geopolitical risk and kept energy prices well behaved."

(With Reuters inputs.)