WRAPUP 2-Cooler US producer inflation hints at softening demand

By Lucia Mutikani

WASHINGTON, Sept 10 (Reuters) - U.S. producer prices unexpectedly fell in August amid a compression in trade services margins and mild increase in the cost of goods, suggesting that domestic firms were probably absorbing some of the tariffs on imports.

The lack of strong producer price pressures, despite import duties, could also be signaling softening domestic demand against the backdrop of a struggling labor market. The Federal Reserve is expected to cut interest rates at its policy meeting next Wednesday, with a quarter-percentage-point reduction fully priced in, after it paused its easing cycle in January because of uncertainty over the impact of President Donald Trump's sweeping import tariffs.

"Inflation barely has a heartbeat at the producer level which shows the tariff effect is not boosting across-the-board price pressures yet," said Christopher Rupkey, chief economist
at FWDBONDS. "As time goes on, one has to wonder if there are slow-growth reasons and weak economic demand that is keeping inflation in check. There is almost nothing to stop an interest rate cut from coming now."

RETAILERS MAY BE EATING TARIFF COSTS

The Producer Price Index for final demand dipped 0.1% last month after a downwardly revised 0.7% jump in July, the Labor Department's Bureau of Labor Statistics said on Wednesday. Economists polled by Reuters had forecast the PPI would advance 0.3% after a previously reported 0.9% surge in July.

A 0.2% drop in services prices accounted for the fall in the PPI. That decrease followed a 0.7% rebound in July. Services last month were held down by a 1.7% decline in margins for trade services, reflecting a 3.9% decrease in margins for machinery and vehicle wholesaling.

"It does look like retailers have been eating tariff costs in recent months," said Stephen Stanley, chief economist at Santander U.S. Capital Markets. "This is quite consistent with the commentary from second-quarter earnings reports and other anecdotal evidence. Firms have consistently said that they have held the line as long as they could, but that they would need to begin selectively hiking prices going forward."

The cost of services less trade, transportation and warehousing, however, increased 0.3% while prices for transportation and warehousing services shot up 0.9%.

Portfolio management fees increased 2.0%. Airline fares rose 1.0% while the cost of hotel and motel rooms increased 0.9%. Prices for dental services accelerated 0.6%.

Goods prices edged up 0.1% after increasing 0.6% in the prior month. Food prices gained 0.1%, with declines in the costs of eggs and fresh fruits partially offsetting more expensive beef and coffee because of tariffs. Wholesale beef prices surged 6.0% and were up 21.1% from a year ago. Coffee vaulted 6.9% and increased 33.3% on a year-over-year basis.

Energy prices fell 0.4%. Excluding the volatile food and energy components, producer goods prices rose 0.3%, indicating some pass-through from tariffs. The so-called core goods prices gained 0.4% in July. In the 12 months through August, the PPI increased 2.6% after climbing 3.1% in July.

FED EXPECTED TO CUT INTEREST RATES

Trump seized on the tame producer inflation to demand a big rate cut from Fed Chair Jerome Powell, whom he derisively calls "Too Late."

"Just out: No Inflation!!! 'Too Late' must lower the RATE, BIG, right now," Trump wrote on his Truth Social media platform.

Stocks on Wall Street were mostly trading up, with the S&P 500 .SPX and Nasdaq Composite .IXI indexes hitting intraday record highs. The dollar slipped against a basket of currencies. U.S. Treasury yields fell.

Economists, however, cautioned against complacency on inflation, arguing that the PPI readings were too volatile.

"More than anything, they likely reflect ongoing adjustments in business strategies to deal with the tariffs," said Oren Klachkin, financial market economist at Nationwide. "Going forward, tariff impacts will be somewhat easier to see in the second half (of the year) now that businesses have drawn down their inventories and certain tariff reprieves have ended."

The impact of tariffs may be reflected in the consumer price data due to be released on Thursday. A Reuters survey of economists forecast the Consumer Price Index increased 0.3% last month after climbing 0.2% in July.

Consumer prices are expected to have advanced 2.9% on a year-over-year basis in August after rising 2.7% in July. Core CPI inflation is predicted to have increased 0.3% for a second straight month. That reading would keep the annual increase in core CPI inflation at 3.1%.

Firmer consumer inflation would add to labor market weakness in fueling concerns that the economy was in danger of stagflation. The government estimated on Tuesday that the economy likely created 911,000 fewer jobs in the 12 months through March than previously estimated.

That data followed the release last Friday of the monthly employment report, which showed job growth almost stalled in August and the economy shed jobs in June for the first time in four and a half years.

"The Fed is almost certain to cut rates in light of worsening labor market conditions, but slow growth and higher prices continue to punish American families," said Elizabeth Pancotti, managing director of policy and advocacy at Groundwork Collaborative.