Wholesale prices were unchanged in July, coming in below expectations for a 0.2% increase. The Producer Price Index was flat after a revised 0.1% decline in June, while the annual rate fell sharply to 4.7% from 5.5%. Wholesale prices are still 4.7% higher than a year ago, and beneath that flat headline number there are several very different forces moving in opposite directions.
The primary reason July looked so tame was goods, and particularly energy. Final-demand goods prices declined 0.7%, with energy falling 3.1% and food dropping 0.9%. This follows the enormous energy shock earlier this year when final-demand goods surged 2.8% in May, the largest monthly increase since that series began in 2009. Energy jumped 10.7% that month and gasoline alone surged 23.4%. You cannot look at the subsequent decline and pretend the original price increase never occurred. Energy exploded, retreated from that spike, and therefore dragged July’s monthly PPI downward.
This is precisely why I would be extremely cautious about declaring victory over inflation. July PPI probably did not fully capture the late-July increase in oil prices. Energy works its way through virtually everything because businesses do not simply purchase gasoline. They pay for diesel, electricity, transportation, plastics, fertilizer, chemicals, refrigeration, manufacturing, shipping, and eventually higher insurance costs when geopolitical tensions threaten transportation routes. A temporary decline in petroleum can make an inflation report look beautiful for a month, but if energy reverses, those costs begin working their way through the entire production chain again.
Services tell a very different story from goods. Final-demand services increased 0.2% in July, and portfolio-management fees surged 6.5%. Freight transportation costs declined 1.8%, providing some relief, but the underlying service economy remains under pressure.
Producer prices excluding food and energy increased 0.2% in July and remained 4.2% higher than one year ago. More importantly, the measure excluding food, energy, and trade services increased 0.4% for the month and 4.7% annually. That tells us that once you strip away the volatile decline in energy and some of the distortions from trade margins, underlying producer inflation is hardly sitting at the Federal Reserve’s 2% target.
This is the problem with reducing inflation to a single number. A farmer looks at fertilizer, diesel, machinery, interest rates, seed, labor, and transportation. A restaurant owner looks at food, electricity, rent, wages, insurance, and financing. A manufacturer looks at commodities, energy, components, shipping, tariffs, and borrowing costs. Each business experiences a completely different inflation rate, and eventually those costs either have to be absorbed through lower profit margins or passed along to consumers.
CPI rose only 0.1% in July and 3.4% annually, while core CPI came in at 2.5%. Now PPI has also surprised to the downside, and naturally everyone will begin demanding that the Federal Reserve ease. Reuters reports that the federal funds rate remains at 3.50% to 3.75%, while the latest inflation and labor data strengthen the argument for leaving rates unchanged at the September meeting rather than tightening further. Estimates derived from the latest inflation data put July core PCE at approximately 0.2% for the month and 3.3% annually.
There is also a tremendous difference between producer inflation and consumer inflation because companies do not pass costs through immediately. Businesses initially absorb higher expenses by reducing margins, changing suppliers, shrinking products, eliminating employees, automating operations, or postponing investment. Only when those measures become insufficient do they raise prices aggressively. PPI therefore gives us a look into the pipeline, but it does not tell us exactly when or how much of that pressure ultimately reaches the consumer.
This is particularly important now because American businesses are already dealing with a consumer who is stretched thin. Grocery spending is slowing, small-business bankruptcies are rising, foreclosures are increasing, credit card balances remain enormous, and households are becoming increasingly price-sensitive. Companies may therefore have less ability to pass higher costs onto customers even when their own expenses increase. That does not necessarily eliminate inflation. It can instead destroy margins and eventually businesses, which is an entirely different economic problem.
The July report is certainly better than another 2.8% explosion in goods prices like we saw in May, but it does not demonstrate that inflation has been defeated. Goods fell because energy and food provided substantial relief while services continued higher and the broad core measure excluding food, energy, and trade services rose 0.4%. The annual PPI remains 4.7%, and the late-July oil increase may not yet be fully reflected in these numbers. That is hardly an environment where anyone should assume prices are about to return to what Americans remember before the inflationary surge.
What we are seeing is inflation moving through different layers of the economy at different speeds. Energy can plunge one month and surge the next, commodities respond to war and supply, services remain sticky, businesses absorb costs until their margins break, and consumers finally see whatever remains at the end of that chain. July provided relief at the wholesale level, but the underlying numbers remain far too elevated to declare that this cycle is finished.