As an investor, you know that the market is always fluctuating, right? But have you ever wondered why the prices of the products we buy change so often? How to limit this situation? The PPI will help predict and measure the market. Don’t miss the opportunity to explore this mystery, take a few minutes to follow the article below!
What Is the Producer Price Index (PPI)?
PPI is a measure of how much the prices that producers pay or receive when buying or selling goods and services have changed compared to a previous point in time. For example, if the price of raw materials increases, producers will have to increase the prices of their products to cover the costs, and this will be reflected in the Producer Price Index.
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Relationship with inflation
PPI is a measure of the average prices that producers pay or receive when buying or selling goods and services. Imagine you are a bread producer. If the prices of flour, eggs, milk, etc. (raw materials for making bread) increase, you will have to increase the price of bread to cover the costs. This means that the general price of goods will increase, causing inflation.
Therefore, Producer Price Index is considered a “harbinger” of inflation. When PPI increases, it shows that the production costs of businesses are increasing, and they are likely to increase the prices of their products in the future, leading to inflation.
PPI and inflation are closely related. When Producer Price Index increases, the risk of inflation also increases. Therefore, economists, investors and governments often monitor Producer Price Index very closely to make appropriate decisions.
PPI vs CPI
PPI and CPI are two indices that look similar but have their own differences. Both measure price changes, but the way they are measured and what they measure have certain differences.
PPI (Producer Price Index)
Measures the change in prices that producers pay or receive when buying or selling goods and services. In other words, Producer Price Index tells us how the prices of input materials, components, energy, etc. have changed.
CPI (Consumer Price Index)
Measures the change in prices of a basket of consumer goods and services that people buy every day, such as food, housing, electricity, water, etc.
Normally, when PPI increases, CPI also tends to increase. Because when input prices increase, manufacturers will have to increase their selling prices to compensate for the costs, leading to an increase in the prices of consumer goods.
However, the CPI does not always increase by the same proportion when Producer Price Index increases. There are many other factors that can affect CPI, such as exchange rates, monetary policy, market competition, etc.
For example, suppose oil prices increase. This will increase the production costs of many industries, leading to an increase in Producer Price Index. Manufacturers will have to increase their selling prices, and eventually the prices of gasoline and consumer goods will also increase, causing CPI to increase.
How PPI Is Measured?
There are many ways to measure PPI, but the three main ones are based on the stages of production:
- Commodity Index: Measures the change in the price of raw materials, that is, things used to start the production process. For example: iron ore (for making steel), aluminum scrap (for recycling aluminum), soybeans, wheat (for food). It shows how the input costs of manufacturers are changing.
- Processing Stage Index: Tracks the change in the price of goods in the production process, that is, materials that have gone through some processing but are not yet the final product. For example: refined sugar (processed from sugar cane), leather (processed from animal hides), paper, basic chemicals. It shows how the cost of production changes at the intermediate stages.
- Core PPI: Focuses on the prices of finished goods, that is, products that are finished and ready to be sold to consumers. This is often the index that economists are most interested in when it comes to Producer Price Index. Examples: shoes, soap, tires, furniture.
In addition, PPI is also divided into:
- Input: Reflects the costs that manufacturers pay for raw materials and services to produce goods.
- Output: Reflects the prices at which manufacturers sell their products to buyers.
How to calculate PPI
To calculate Core Producer Price Index, prices of volatile items such as energy and food are excluded. Because their prices are often affected by temporary factors (e.g., bad weather affecting crops, political turmoil affecting oil prices), the index is difficult to compare over the long term.
PPI is calculated by comparing current prices with prices from a base year (for example, 1982 is taken as the base year with a value of 100). A weighted average of the prices of the items is then calculated. The weight of each item depends on its importance in the economy. For example, plastic bottles and household lubricants have a larger weight than candles or umbrellas because they are produced and consumed in larger quantities. The total weight of all items is calculated as 100%.
Nowadays, Producer Price Index is often calculated by including the cost of services and construction activities, not just focusing on goods as before, to reflect a more comprehensive picture of price changes in the economy.
Use The PPI Strategy
The Producer Price Index is a useful tool for traders to predict market trends and make smart investment decisions. Here are some specific ways that is used:
Assessing the inflation situation
- When the PPI report is released, compare the actual figures with the previous forecast. If the Producer Price Index rises higher than expected, this indicates that inflationary pressures are increasing and may lead to monetary policy tightening measures by the State Bank.
- Look at the long-term trend of PPI to assess the overall inflation situation of the economy. A sustained upward trend of Producer Price Index may signal a period of higher inflation.
Assessing the impact on monetary policy
The State Bank often looks at PPI to make decisions on interest rates. If Producer Price Index rises, the State Bank may raise interest rates to curb inflation, which will affect the financial market.
Portfolio selection
When PPI increases, input prices increase, manufacturing companies will be under great pressure. Therefore, investors can consider selling stocks of these companies. On the contrary, when interest rates increase, banks will benefit. Investors can consider buying stocks of banks.
Gold is frequently considered a safeguard against inflationary pressures. Rising inflation concerns can correlate with increases in the price of gold.
Assess the impact on industries
An increase in Producer Price Index can increase production costs for businesses, putting pressure on profits and stock prices. On the contrary, a decrease in PPI can improve the profits of manufacturing companies.
An increase in Producer Price Index can lead to an increase in the selling price of goods, affecting consumer spending and reducing demand.
Compare with other indicators
Compare PPI with the consumer price index (CPI) to assess the level of inflation at both the production and consumption stages.
Combine Producer Price Index with other economic indicators such as GDP, unemployment rate to have a more comprehensive view of the economic situation.
Market reaction
Observe the reaction of the stock market after the Producer Price Index report is released. If PPI increases higher than expected,the domestic currency may be under pressure to depreciate, the market may decline, especially the manufacturing sector.
Conclusion
In conclusion, PPI is an important tool to help us track price trends, predict inflation and make trading decisions. However, to make it easier to succeed, you should combine it with other indicators and prepare yourself a thorough trading strategy.
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