German PPI Is Off Sharply But It’s the Usual Dilemma

The German PPI is falling by 1.1% in July compared to June. The PPI now has a string of months in which prices are falling. This in fact looks even more persuasive because the PPI ex-energy fell by 0.4% in July, and it also has a string of months in which inflation is falling. But it’s only PPI inflation, not the sky. Central banks do not target producer prices. Table 1 also shows for comparison what's going on with the CPI; it has increased in two of the last three months. The CPI ex-energy has also increased in two of the last three months. As you look at these trends more broadly, producer prices are in fact coming to heel very sharply. And more than that, PPI prices are weak. However, consumer prices have hardly benefited from this trend at all.

The PPI excluding construction in Germany has fallen by 6% over 12 months; it falls at a 10.1% annual rate over 6 months and falls at a 10.4% annual rate over 3 months. That's impressive weakness. The PPI excluding energy rises 2.1% over 12 months, falls at a 1.1% annual rate over 6 months and falls at a 3.9% annual rate over 3 months indicating ongoing deceleration in the PPI ex-energy.

In comparison, the CPI, which is emphasized by the ECB (it targets the HICP), is up by 6.1% over 12 months; however, the pace slows to 3.5% over 6 months and slows further to 1.7% over 3 months. This declining progression brings the 3-month growth rate inside the target range for the ECB, but again central banks do not typically place a great deal of weight on these shorter-term compounded inflation rates. Looking at the CPI ex-energy we also see a 6.1% gain over 12 months, a 4% annual rate gain over 6 months, and a 2.5% annual rate gain over 3 months. Once again, we see clear inflation deceleration and progress but less deceleration than for the headline and even over 3 months there is less good news when the CPI ex=energy fails to drop inside of the ECB target range.

The chart (on the right) plots the PPI ex-energy against the CPI ex-energy. The chart is perhaps the best way to understand the stark difference and the difference in trend between these two metrics. The chart gives you a hint that historically the PPI is more volatile than the CPI and that it goes through exaggerated cycles in comparison with the CPI. In other words, just because the PPI accelerates sharply or decelerates sharply doesn't mean the CPI will run the same magnitudes; however, usually, the accelerations and decelerations of the PPI are reflected in some acceleration or deceleration in the CPI. It's just less pronounced. That seems to hold in this cycle as well.

Table 2 (below) provides a longer time series of data and one with a different perspective as it looks at period-to-date inflation. This table looks at one-year-to-date inflation rates, then two-year-to-date, then three-year-to-date, all the way out to 10-year-to-date.

Brent prices are not lower on a year-to-date basis except for the one-year calculation and going far back in the 9-year-to-date and 10-year-to-date periods. That tells us that the current level of energy prices is not only low over the past year, but that when we take a look at oil prices compared to where they were 9 to 10 years ago, they are lower today averaging an annual rate drop over 9- or 10-years of 3% percent per year. That is a nice proportion of PPI inflation to have blunted over such an extended period. This table makes it quite clear that the current metrics on the PPI, while extremely impressive in terms of showing inflation falling and weak, is only a one-year phenomenon. When we take this price weakness and mix it in with a year ago results, prices are still higher and up at a 13.6% annual rate: ex-energy higher at an 8% annual rate.

This time-series reminds us how long CPI prices have been elevated. The ECB inflation target of 2% is chronically violated for the German economy by the CPI or the CPI ex-energy. Both are more than that goal over all these time horizons. In other words, inflation in the EMU has become entrenched at least that's true for Germany which many people would find surprising and who, before the formation of the EMU, would have thought that development to be unlikely.

The same stalemate plays out in a lot of places where the headline inflation rate is falling, and the core inflation rate is more stubborn. And the dichotomy between the performance of the PPI and the CPI is also a common theme internationally. Of course, raw materials and especially oil prices have larger weights in the PPI, accounting for why PPI prices are weaker. Consumer prices, of course, have a larger service sector component and the service sector is more wage-intensive and since COVID labor markets have been tight and wage costs have been high and this goes part of the way to explain why consumer prices have been higher, stubborn, and harder to fall than producer prices.

While I do not dismiss the PPI, it is not the price index of choice for policymakers. It does suggest that there's raw material feeding into the CPI that can continue to bring CPI prices lower. However, we should also be aware that the PPI boomed much more than this CPI did; therefore, it will inevitably bust to a much greater extent as well with lesser impact on the CPI as the chart demonstrates. My main comment is that markets should be tempered in their willingness to look at the PPI and to try to project optimism from it. The longer-term inflation chart for Germany suggests that would be the wrong approach.