Producer Price Index Drop Supports Fed's Position on Keeping Low Interest Rates

The Producer Price Index (PPI) saw its biggest drop in seven months in February, fueling the U.S. Federal Reserve's argument that interest rates can remain low "for an extended period" without yet facing dangerous inflationary pressures.

Wholesale prices were down a seasonally adjusted 0.6% in February, the Labor Department reported today (Wednesday), a day after the Fed's one-day policy meeting where it reiterated the need to encourage economic growth through low interest rates.

The central bank's position to keep the federal funds rate at a record low range of zero to 0.25% since December 2008 has sparked inflation concerns among many investors. However, proof of tame inflation buys the Fed more time in deciding when to continue with its "exit strategy" and pull the trigger on a rate hike. The Fed has remained firm on its stance that there is no evidence of rising inflation due to low interest rates.

"With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time," the Fed said in a statement yesterday (Tuesday).

Economic recovery has begun but at a slow pace, and companies are not likely to raise prices much before there's more job growth - and unemployment is still at an uncomfortably high level of 9.7%.

"Disinflation is going to be with us for a while," Julia Coronado, a senior U.S. economist at BNP Paribas in New York, told Bloomberg. "That's going to allow the Fed to stay on hold for a lot longer than the market is expecting."

The PPI drop followed a 1.4% January gain. The decrease was largely driven by gasoline prices, which fell 7.4% from last month after an 11.5% climb in January. Overall, energy prices fell 2.9%, and food prices rose for the second consecutive month by 0.4%.

Core producer prices - which exclude food and energy - are more closely watched by the Fed, and rose 0.1% in February, matching economists' expectations. Core costs were led higher by rising wholesale auto prices.

Producer prices were up 4.4% from February 2009, slimming January's year-over-year increase of 4.6% and falling below predictions of 4.9%. Economists say this is not elevated enough to cause inflation concerns.

"The bottom line is it looks like the price pressures are pretty moderate in terms of core producer prices right now. It doesn't suggest there is any kind of generalized inflationary pressures building up in the production pipeline," Jonathan Basile, an economist at Credit Suisse Group AG (NYSE: CS) in New York, told Reuters.

Economists in a Bloomberg survey had only predicted a slight 0.2% drop in the PPI.

The PPI is one of three measures of inflation that include the cost of imported goods - which fell by 0.3% in February - and the Consumer Price Index (CPI). The government will release CPI numbers Thursday. Predictions have it rising by 0.1%.

The PPI data and the Fed's policy meeting sentiment were just a couple pieces of this week's global news that helped rally markets Wednesday.

"Indications from the US Fed on Tuesday that interest rate increases may be some time away yet, a benign US producer price report, signs that the US financial system continues to heal with more TARP [Troubled Asset Relief Program] repayments and continued easing of sovereign debt fears in Europe this week all appear to be contributing to improved market sentiment," Colin Cieszynski, market analyst at CMC Markets, told Financial Times.

News and Related Story Links: