Why Investors Care
The IPPI reflects the prices that Canadian producers receive when goods leave the factory gate, that is, what producers receive for their output. This index is similar to the United Kingdom's producer output index. The index includes prices for major commodities sold by manufacturers, but it excludes indirect taxes and items such as transportation and wholesale and retail costs. The index is affected by the foreign exchange rate of the Canadian dollar versus the U.S. dollar, and each month its impact is noted. The RMPI reflects the prices paid by Canadian manufacturers for key raw materials, either domestically or in world markets. It is published simultaneously with the IPPI and, like that index, has a base year of 1997 and is subject to revisions for six months. This index is analogous to the producer input price index published in the United Kingdom.
The IPPI and RMPI measure prices at the producer level before they are passed along to consumers. Since these indexes measure prices of consumer goods and capital equipment, a portion of the inflation at the producer level gets passed through to the consumer price index (CPI). By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months.
While the CPI is the price index with the most impact in setting interest rates, the PPI provides significant information earlier in the production process. As a starting point, interest rates have an "inflation premium" and components for risk factors. A lender will want the money paid back from a loan to at least have the same purchasing power as when loaned. The interest rate at a minimum equals the inflation rate to maintain purchasing power and this generally is based on the CPI. Changes in inflation lead to changes in interest rates and, in turn, in equity prices.
The PPI is considered a precursor of both consumer price inflation and profits. If the prices paid to manufacturers increase, businesses are faced with either charging higher prices or they taking a cut in profits. The ability to pass along price increases depends on the strength and competitiveness of the marketplace.