U.S. Producer Prices Sank in February, Yet this Retraced only a Portion of the January Surge

February producer prices came in weaker than expected dropping 0.6% in the month. Expectations had been for a decline but by a more moderate 0.2%. On a year-over-year basis, prices are still rising by a sizeable 4.4% although this is down from the 4.6% recorded in January 2010. Much of this upward pressure on an annual basis reflects the effect of energy prices, which are up 16.6% on an annual basis in February despite a monthly decline of 2.9%.

Going into the producer price report, expectations had been for a drop in prices although by a more moderate 0.2%. The anticipated decline was premised on indications of weakness in gasoline prices, yet the actual 7.4% drop reported this morning retraced a greater than expected share of the 11.5% rise in January. This morning’s report also showed a sizeable 5.6% monthly drop in heating oil. These declines helped to offset another 0.4% rise in food prices that matched the gain in January.

Eliminating the effect of the volatile food and energy components, core prices rose an expected 0.1% in the month down from a 0.3% rise in January. The minimal gain in the core component occurred despite a marked 0.5% rise in passenger car prices that retraced an equal-sized drop in January. This increase was tempered by modest 0.1% price declines in capital equipment, tobacco products and light trucks. An even greater decline in the light-truck component had been expected given the 1.9% surge recorded in January. On a year-over-year basis, core prices are up only 1.0%, which was unchanged from both the January rate and the average rate of increase over the previous-four months.

The negligible rise in core prices after the outsized 0.3% gain in January will provide reassurance that inflation pressures, at the producer level, are not building up in the system. This reinforces the view that the slack built up over the course of the recession, and evidenced by a still-high rate of unemployment, is keeping inflation pressures contained. This will allow any tightening in policy to be in a large part determined by how quickly the unused capacity is being absorbed. Given our forecast of modest, near-term growth and limited downward pressure on the unemployment rate, the tightening in policy is expected to be gradual. Fed funds is only projected to start rising from its current range of 0% to 0.25% by the fourth quarter of 2010 and is expected to finish the year at a still very accommodative 0.75%.

RBC Financial Group
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The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.