Led by solid gains in food and energy, headline PPI increased a stronger-than-expected 0.5 percent in May. Our modest GDP forecast for the second half of the year should not be problematic to the inflation outlook.

Food and Energy Post Solid Increases

Ending a two-month down streak, finished goods prices increased a stronger-than-expected 0.5 percent in May as gains were broad based. One of the typical drivers of the PPI report, energy, proved to be a factor this month. Following back-to-back declines in April and March, finished energy prices advanced a solid 1.3 percent in May as a 1.5 percent gain in gasoline prices accounted for forty percent of the sector’s increase. Strength was witnessed elsewhere in the sector as residential natural gas and electric power also rose on the month. The index for finished consumer foods, another key variable, picked up 0.6 percent, largely on a 42 percent jump in egg prices. Year-over-year, finished consumer foods are up 3.0 percent. 

Stripping out food and energy, core producer prices were little changed on the month, advancing just 0.1 percent. Nearly two-thirds of the core’s increase is attributable to the 0.4 percent rise in light trucks. The year-over- year rate of core PPI remained unchanged at 1.7 percent, signaling there really is still not much inflationary pressure in the U.S. economy.

Further back in the production pipeline, the price environment continues to remain soft. While headline crude goods rose 2.2 percent and intermediate goods were virtually flat, the core measures of both processing stages declined. Core intermediate prices fell for the second straight month, down 0.4 percent, and core crude goods prices dropped 2.3 percent. With core year-over-year measures still in negative territory, disinflationary pressures for goods prices should continue to move through the production pipeline in the coming months.

Second Half Outlook

We have almost reached the midpoint of the year and the growth and inflation forecasts we had back in December 2012 have largely unfolded as anticipated. U.S. GDP growth has remained relatively soft given the headwinds of the higher taxes, the sequester and ongoing outlook uncertainty. Sluggish global demand has weighed on commodity prices and has helped keep headline producer prices in check as evidenced by the modest 1.7 percent year-over-year gain. As Europe hopefully stabilizes, we expect to see a pick-up in demand in the second half of the year. While growth here in the United States should rise back toward a 2 percent annual rate after pulling back to around a 1.5 percent pace in the second quarter, a significant amount of economic slack should continue to limit upward price pressure both at the producer and consumer levels. Moreover, the continuation of the low inflation environment well below the Fed’s longer-run target is likely to keep the FOMC members concerned and therefore unlikely to alter monetary policy at next week’s meeting.