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Inflation still alive and well at the producer level

June Producer Price Inflation came in a bit stronger than expected, despite the biggest decline in energy prices in two years. Although the headline PPI fell by 0.4% during the month, the more important number is the core PPI, which rose by 0.3%, vs. an expected rise of 0.2%. On a six-month annualized basis, the headline number is now 8.1%, and the core number is 3.7%. The core PPI hasn't risen this fast since April 1991.

That core prices are rising is a reflection of the strong gains in commodity prices that are making their way through the production pipeline. It is also a reflection of the fact that monetary policy is quite accommodative, since it is not trying to fight higher energy prices. If policy were tight, then higher energy prices would have forced declines in non-energy prices, but that is not happening. Since producer prices are more sensitive to commodities than the CPI, the PPI is thus like the canary in the coal mine, predicting higher inflation on the way in the CPI.

It's also important to note that rising inflation is showing up at the producer level, despite the substantial amount of economic "slack" that presumably exists in the U.S. economy. This casts doubt on the widely-held belief, which the Fed shares, that today's large output gap will be an important restraining force on inflation.

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