- The Washington Times - Thursday, February 20, 2003

WASHINGTON, Feb. 20 (UPI) — The Labor Department said Thursday the Producer Price Index, a key measure of inflation at the wholesale level, posted its largest increase during January in 13 years as the cost of oil skyrocketed.

The government said the PPI surged 1.6 percent during the first month of 2003 — its largest rise since climbing a 1.9 percent in January 1990.

Most economists on Wall Street were expecting the PPI to rise 0.5 percent during the month after falling a revised 0.1 percent in December, which the government originally reported as no change during the final month of 2002.

Excluding the often volatile food and energy sectors, the so-called core PPI climbed 0.9 percent after falling 0.5 percent in December. The rise in the core-rate was the largest since a 1-percent increase posted in December 1998.

Most economists on Wall Street were expecting the core rate to rise 0.1 percent.

Wall Street watches producer prices to determine whether inflationary pressures are building.

The PPI is a measure of the average price level for a fixed basket of capital and consumer goods paid by producers. It measures price changes in the manufacturing sector. Inflation at this producer level often gets passed through to the consumer price index. By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months. Investors need to monitor inflation closely. Just knowing what inflation is and how it influences the markets can put an individual investor head and shoulders above the crowd.

Inflation is a general increase in the prices of goods and services. The relationship between inflation and interest rates is the key to understanding how data such as the PPI influence the markets.

If someone borrows $100 from you today and promises to repay it in 1 year with interest, how much interest should you charge? The answer depends largely on inflation, because you know that the $100 won't be able to buy the same amount of goods and services a year from now. If you were in Brazil, where prices can double every couple of months, you might want to charge 400 percent interest for a total payoff of $500 at the end of the year. In the United States, the CPI tells us that prices are rising about 2 percent a year, so you only have to charge 2 percent interest to recoup your purchasing power at the end of the year. You might want to add in a few more percentage points for default risk and the opportunity cost, but the key variable in what interest rate you charge is the rate of inflation.

That basically explains how interest rates are set on everything from your mortgage and auto loans to Treasury bonds and T-bills. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates accordingly. The effect ripples across stocks, bonds, commodities and your portfolio, often in a dramatic fashion.

By tracking the trends in inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform.

The latest report from the Labor Department showed energy prices posted their largest gain since June 2000, surging 4.8 percent in January after rising 0.2 percent in December. Gasoline prices skyrocketed 13.7 percent, the most since last October.

Oil prices in January exceeded $33 a barrel for the first time in two years amid the prospect of war with Iraq and a strike in Venezuela. Prices have jumped to a 29-month high in February. The average price rose to $36.80 a barrel in the first 14 days of the month.

The report showed new-automobile wholesale prices climbed 3.5 percent after falling 2 percent in December. Core wholesale prices, excluding new vehicles, rose 0.3 percent, the Labor Department said.

Food prices rose 1.6 percent after rising 0.4 percent in December. Prices of intermediate goods rose 1.3 percent after declining 0.2 percent a month earlier.

Excluding food and energy, intermediate prices rose 0.3 percent after dropping 0.1 percent in December.

Prices for crude goods, which are used at the earliest stage of production, jumped 6.9 percent. The cost of crude goods, excluding food and energy, gained 1 percent after posting a 0.5-percent rise in December.

Prices for capital equipment such as machinery, tools and computers rose 0.7 percent after declining 0.4 percent in December.

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