Manufacturing Margins Near 3 Year Low

26 Jul 11

The broad measure of business inflation – the producer price index (PPI), or final stage prices, – rose by 0.8 per cent in the June quarter, in line with forecasts. Inflation was narrowly based with just three factors – building material prices, oil prices and flood-affected crop prices – accounting for all the increase in the PPI.

The gap between manufacturing output prices and input prices is the lowest in 2.5 years (-5.9 percentage points) – pointing to pressure on manufacturing profits.

According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 1.1 cents per litre to an eight-week high of 141.8 cents a litre in the week to 24 July. Today, the wholesale price stands at 133.2 cents a litre and it averaged 133.6 cents over the past week.

The key message for motorists is to shop around. Petrol could be purchased for around $1.29 a litre in Sydney over the weekend with shopper dockets – four cents below the wholesale price.

What does it all mean?

The producer price index doesn’t track the consumer price index very closely, as it tends to be influenced by volatile factors such as the global oil price and the Australian dollar.

Still, it’s worth keeping an eye on in order to track the cost pressures facing business and the implications for profitability. In the current environment – with consumers closely watching their pennies – it’s more likely that businesses would seek to absorb higher costs rather than passing them through to final buyers. So cost pressures would have greater relevance on profitability rather than inflation.

At face value, it appears that businesses are absorbing higher raw material prices. That certainly seems to be the case in manufacturing. The gap between selling prices and input costs has been narrowing for two years and it now stands at a near three-year low. Manufacturers are finding it hard to pass-through higher costs and profitability is the casualty.

It’s important to note that business inflation is very narrowly based at present with just three factors – building material prices, oil prices and flood-affected crop prices – accounting for all the increase in the producer price index in the latest quarter. Overall, 17 of the 50 categories recorded weaker prices in the quarter with the stronger Aussie dollar proving the key influence.

It’s also worth noting that economists find it harder to forecast the producer price index rather than the equivalent measure of consumer prices – thus the wide range of forecasts. So the fact that the PPI actually rose in line with forecasts doesn’t really mean too much – actually only two forecasters got it spot on.

The Consumer Price Index is released on Wednesday and forecasts are more tightly grouped. Most expect prices to be up in the June quarter between 0.6-0.9 per cent with the underlying rate seen up between 0.6-0.8 per cent.

Overall, the annual rate of underlying inflation is expected to be close to 2.5 per cent – right in the middle of the Reserve Bank’s two to three per cent target band.

Given the softness of the economy, we expect the Reserve Bank to stay on the interest rate sidelines for the next three to four months at least. Consumers are saving, not spending. Businesses are also being cautious about employing and investing – especially outside the small mining sector (just eight per cent of the economy).

There is nothing in the latest PPI data to unduly worry the Reserve Bank. Strip out higher oil prices and the floods and most businesses are choosing to leave prices unchanged – that is, outside the building sector.

Australian petrol prices may edge a little higher over the next week, but by and large they are unlikely to change markedly in the short-term. The Singapore gasoline price has lifted just over five cents a litre from the lows, the Australian wholesale price has risen around five cents and the retail price has lifted around three cents a litre. The good news for motorists is that the wholesale petrol price has eased over the past four days after a fortnight of gains.

The message to motorists hasn’t changed – it’s a case of picking the right time to fill up. The wholesale price is around $1.33 a litre whereas motorists in Sydney could have filled up closer to $1.29 over the weekend with the help of shopper dockets. Pick the wrong day to fill up and it could cost you almost $15 more to fill up.

What do the figures show?

The Producer Price Index (PPI), or final stage prices, rose by 0.8 per cent in the June quarter to stand 3.4 per cent higher than a year ago. Economists had tipped a lift of 0.8 per cent (wide range of flat to 1.2 per cent). Previously, in the March quarter, the PPI rose by 1.2 per cent to stand 2.9 per cent higher than a year ago.

The Bureau of Statistics notes that the 0.8 per cent lift in final stage prices was “mainly due to rises in the prices received for building construction (1.2 per cent), petroleum refining (10.3 per cent) and other agriculture (7.9 per cent)” and “partly offset by falls in the prices received for industrial machinery and equipment manufacturing (negative two per cent).”

Consumer good prices rose by 0.9 per cent in the quarter while capital good prices rose by 0.7 per cent. Over the year, prices of consumer goods rose by 5.3 per cent, while capital goods rose 1.9 per cent.

Manufacturing output prices rose by 0.9 per cent in the June quarter to stand 3.6 per cent higher than a year ago. But manufacturing input prices rose by 3.7 per cent in the quarter to be up 9.5 per cent over the year. The -5.9 percentage point gap between output and input inflation is a 2.5-year high. The quarterly -2.8 percentage point gap is the biggest in three years.

Article written by Craig James (Commsec) distributed by Switzer Business News