Producer Price Index is an essential economic data that signals the future inflation of an economy. Financial market traders use this data to predict the strength and weakness of a currency pair. PPI is an essential fundamental analysis tool which most of the forex traders should know about.
13 July, 2020 | AtoZ Markets – Producer Price Index (PPI) is an economic indicator that shows a relationship between inflation and interest rate. Traders use producer price index and interest rates and evaluate their relationship to predict the upcoming currency pair movement.
If you want to build your trading career based on fundamental analysis, you should how to trade with PPI. In the following section, we will see what the PPI is and how we can use this indicator in our trading strategy.
What is the Producer Price Index?
PPI is the short form of producer price index that measures the price change of finished goods and services sold by producers. PPI shows the monthly variation of price and well purchased by manufacturers
If you want to use this tool in your trading strategy, you should know the calculating method. There are three examination areas in producer price index:
- Industrial-based and
- stage-of-processing-based companies.
Buro of labor statistics releases this data. The make a survey of retailers by a sampling process and take the average data. Traders use this data as a percentage change form the earlier month and year to predict the impact in the price.
How to Calculate the PPI
PPI is the equal ration of the current price of dividend, which is divided by the base price of a basket:
PPI= (current price of the basket)/ (base price of the basket)
In this calculation, the basket price means relative weights at the current or base years or even some other year.
The formula of PPI based on weighted based current year quantities are mentioned below:
q0= the quantity in the base period,
qt= the quantity in the current period
pt= the current price of the product and
p0= the price of the product in the base year,
PPI Regional Data
The Bureau of Labor Statistics also separates the PPI depended on areas. Every month, the report has broken out into the four significant Census locales:
Three important metro areas are additionally broken out every month. The areas are:
- Los Angeles-Riverside-Orange County
- New York-Northern NJ-Long Island
Along with the local data given every month, the Bureau of Labor Statistics likewise distributes reports for 11 new metro regions each month. Also, it distributes reports for an extra 13 metro regions semi-yearly. These reports spread zones with huge populaces and represent to a specific local subset.
Producer Price Index and Inflation
If the producer price index increases it in the case that the consumer cost is rising. As a result, the effect of an increase would affect the consumer price index.
Any increase in the general price is good for the economy, but some considerations must be taken. If the demand for goods and services increases, businesses should increase capital expenditure to meet the demand. However, if the demand increases but the people’s purchasing power decreases, it would create a divergence between the price and demand.
If we look at history, we can see the gasoline price was $0.27 in 1950. Furthermore, the price of a movie ticket was $0.50. However, these days, this price has been increased dramatically due to the change in purchasing power. Central banks intervene in purchasing power by reducing or increasing inflation and interest rates.
PPI and CPI
As a trader, you should know how to evaluate the result and compare it with other fundamental indicators. The consumer price index indicates daily consumer spending. If the purchasing power of money decreases, the Consumer price index will move up. Similarly, with the decrease in the purchasing power of money, the producer price index will increase.
Consumer price index and producer price index move in the same direction wherewith the interest rate. However, these data indicate two different sectors- one is consumer, and the other is business. Any change in interest rate decision affects both consumer and cooperation.
Therefore, if you want to predict the price of a currency pair, you should know how the consumer price index and producer price index are correlated with the interest rate. You may have a sharp fall in currency pair if any unfavorable interest rate decision negatively affects both CPI and PPI.
How Does PPI Affect Currencies?
People can deposit money in the bank to earn interest. On the other hand, people can spend money immediately if consumer prices are low.
If the PPI increases, Central Bank will try to increase the interest rate to make a balance. As a result, people will try to save money in banks to get higher returns than before. With higher PPI and higher interest rates, people will not take money out of the bank.
On the other hand, if the interest rate is low, and the PPI is high, people will be less interested in keeping money in the bank. As the people will take less interest from the banks, they will try to make money out of the bank. In this way, PPI affects the currency, as the currency price is directly related to the interest rate. Any discrepancy in PPI, CPI, and the interest rate would create a decent move either the upside or downside in the financial instrument.
Fundamental traders evaluate these changed to make a profit from it. it is an important concept that applies in forex, stocks, indices, metal and commodities markets.
PPI is one of the core fundamental indicators that most institutional and fundamental traders consider in their trading strategy.
However, there are times when fundamental indicators do not work as we expect, which is called fundamental divergence. Therefore, you should focus on reliable money management tools to get yourself out of the unusual market condition. Overall, trade management is the key to become a successful trader.
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