MARKET ANALYSIS
INFLATION
Inflation concerns the rate at which the general level of prices for goods and services is rising and subsequently, purchasing power is falling.
Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.
Consumer spending can lead to inflation but can also be hindered by an excessive level of inflation as it reduces consumer’s average propensity to consume.
In times of high inflation it is durable luxury goods sales that are affected.
As inflation rises, every currency unit will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a £1 pack of gum will cost £1.02 in a year.
The key measures of inflation are the Retail Price Index and Consumer Price Index; these are released monthly comparing change with the same period the year before. Other indicators to consider in this area are the Producer Price Index and PCE Index.
CONSUMER PRICE INDEX
Country
Type
Inflation
Announced
Monthly (Quartery for Australia and NZ)
Description
This cost-of-living measure is used to adjust a number of contracts that are tied to inflation including labour, social security and tax brackets. Like the PPI, food and energy are often stripped out due to volatility, leaving the ‘core’ CPI.
Commodities constitute 40% of the index and the remaining 60% are services. Bond and equity markets will rally on the heels of small CPI increases, since low inflation translates into low interest rates, which help corporate profits.
RETAIL PRICE INDEX
Country
Type
Inflation
Announced
Monthly, around 15 days after the month end
Description
This general purpose measure of inflation examines a basket of goods which are reviewed and updated each year to reflect changes in the market and best represent consumer spending patterns.
The contents are similar to the basket used for calculating CPI, but the price weights attached to the individual items in each index differ. Category constituents include: Food & non-alcoholic beverages, transport, recreation & culture, miscellaneous goods & services, clothing & footwear, housing & household services, furniture & household goods, alcohol & tobacco, health, communication, education, and restaurants & hotels.
BUSINESS INVENTORIES
Country
Type
Inflation
Announced
Monthly, around 45 days after the month end
Description
This is the dollar amount of inventories held by manufacturers, wholesalers and retailers. The level of inventories in relation to sales is an important indicator of the near-term direction of production activity.
Rising inventories can indicate optimism that sales will grow in the coming months. Examining the ratio of inventories to sales allows investors to see if production demands will expand or contract in the near future.
PRODUCER PRICE INDEX
Country
Type
Inflation
Announced
Monthly
Description
A measure of the average price level for a fixed basket of capital and consumer goods at the producer level before they are passed on to consumers. Investors use this measurement to anticipate inflation in coming months, since a portion of the inflation at the producer level gets passed through to the consumer price index.
If the prices paid to manufacturers increase, businesses face a choice of increasing prices or taking a cut in profits. Food and energy prices, which make up nearly ¼ of PPI, are highly volatile, and many economists strip them out, focusing on ‘core’ PPI.
Bond markets tend to rally when there is little increase or a decrease in PPI, though bonds suffer when PPI rises. Equity markets thrive on PPI increases, as low inflation means low interest rates, and higher corporate profits.
PCE INDEX
Country
Type
Inflation
Announced
Monthly, around 30 days after the month end
Description
The Personal Consumption Expenditures Index (PCE Index) or PCE Deflator is produced by the Bureau of Economic Analysis (BEA) to accompany the National Income Accounts for Personal Consumption Expenditures. The accounts measure personal consumption spending within the United States and therefore have a significant impact on the GDP rate within the world’s largest economy.
Personal Expenditure is the major component of household consumption which is the biggest explanatory factor determining GDP in the USA (the other’s being investment, government expenditure and net exports).
The PCE index calculates the change in the prices paid by consumers and non-profit organisations on consumption goods and acts as an alternative to the Consumer Prices Index (CPI) as a measure of inflation. It generally displays a lower rate than CPI due to differences in formula and scope between the two measures.
In contrast to the CPI Index, PCE is calculated using a ‘Chained Fisher Index’ which uses business surveys from the previous two years to derive weighting, instead of the household survey’s ‘weighted basket of goods’ technique employed by CPI.
This means that the PCE adjusts quicker to changing spending patterns and is more likely to capture the effect of consumers substituting premium products for budget ones in tougher times whereas the CPI Index contains a more rigid set of goods that are only re-calculated when the basket is updated every two years.
Core’ PCE is also released at the same time and excludes the highly volatile components of food and energy.
