US Dollar: Producer Price Data Shows Inflation Pressures Building, to Hold Fed's Feet to the Fire

-Robust producer price data shows inflation uptrend continues.

-Rising inflation pressures hold Federal Reserve's feet to the fire.

-Fed to raise rates each quarter, supporting the USD - for now.

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The Dollar advanced Thursday after producer price data showed US inflation pressures continuing to build in July, adding weight to forecasts that rising consumer prices will hold the feet of Federal Reserve officials to a proverbial fire during the quarters ahead. 

July's producer price index, which measures the prices of finished goods and services sold by manufacturers, stalled to a 0% change during the recent month while the annualised pace of price growth dropped 10 basis points to 3.3%.

The core producer price index, which removes volatile energy and food items from the goods basket, rose by only 0.1% for the month and at an annualised pace of 2.7%. 

"Both the headline and core indexes were constrained by a 0.8% drop in the volatile "trade services" component, which measures profit margins for retailers and wholesalers. This is a correction, following a run of big increases; it likely does not mark the start of a sustained run of smaller core PPI numbers," says Ian Shepherdson, chief US economist at Pantheon Macroeconomics. 

All of Thursday's numbers were a fraction below the consensus but despite this the uptrend in inflation pressures remains clear for many observers to see.

Pantheon's Shepherdson says price pressures will build a bit further throughout the rest of the year given a double digit increase in oil prices thus far in 2018.

And he is not the only one, as economists at Capital Economics said Thursday there are signs that President Donald Trump's trade tariffs are beginning to push up production costs for US manufacturers. 

"For now, manufacturers are absorbing some of that cost increase, with PPI core goods final demand inflation edging up to a more modest 2.8%. But with more tariffs in the pipeline and capacity utilisation high, we suspect that it’s only a matter of time before final demand inflation begins to rise more markedly," says Andrew Hunter, an economist at Capital Economics. 

Markets care about price and inflation data because it has direct implications for interest rates. Changes in interest rates, or hints of them being in the cards, are only made in response to changes in domestic inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"Along with signs that the tightening labour market is pushing wage growth gradually higher, we expect that the keep the Fed raising interest rates once a quarter over the next 12 months," Hunter adds. 

Both headline and core measures of US consumer prices are already at or above the 2% target of the Federal Reserve. And the personal consumption expenditures (PCE) price index, which is the Fed's preferred measure of US inflation, rose at an annualised pace of 1.9% during June. 

The Federal Reserve has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so that the top end of that range hits 3.25% around the end of 2019.

Most analysts now agree that superior levels of US economic growth have bolstered the case for the Federal Reserve to keep raising its interest rate, at a time when the interest rate outlook elsewhere in the world has deteriorated, which has incentivised traders into selling other developed world currencies and buying US Dollars.

As a result, the Dollar index converted what was a 4% 2018 loss into a 3.1% gain during the four months since the middle of April, after having fallen by 10% in 2017 and dropping another 4% during the first quarter of 2018. Analysts divided in their forecasts for where the US Dollar will head next.

The US Dollar index was quoted 0.12% higher at 95.20 following the release Thursday while the Pound-to-Dollar rate was 0.09% higher at 1.2888 and the Euro-to-Dollar rate was 0.12% lower at 1.1594.

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