The U.S. producer price index (PPI) rose 0.8% in January compared to the market expectation of a more muted 0.3% increase. The core rate, which excludes food and energy, rose a more tepid 0.4%, although this too was above the 0.1% rise the market was looking for.

The substantial 0.8% rise in the PPI broke a trend of five consecutive months of declines. Rising energy prices played a big role, rising 3.7% on the month as gasoline prices rose 15% and residential electricity prices were up 0.3%. Excluding energy, producer prices rose a more muted 0.2%.

The unexpectedly strong rise in PPI cannot, however, be attributed to food and energy alone. All categories of finished goods experienced increases except residential gas, computers and food. Capital equipment prices were up 0.5% and prescription prices rose 1.1%. Even the beleaguered vehicle industry saw price rises at the producer level, with passenger car prices rising 0.3% and light trucks up 0.5%.

Further up the production chain, however, prices continued to fall. Intermediate goods fell 0.7% (-1.1% ex-food and energy) and crude goods declined by 2.9% (a 0.1% rise ex-food and energy). Falling prices at the earlier stages of production should keep prices down for the finished goods category in the months ahead.

Despite today's producer price data, we continue to expect U.S. inflation to decelerate over 2009. Economic weakness has generated excess capacity as was demonstrated by yesterday's fall in the capacity utilization rate. Another indication of economic slack, the unemployment rate, has also been on the rise and today's jobless numbers (see below) offer few signs of an imminent trend reversal.

We expect this slack to continue as the U.S. economy continues contracting through the first half of 2009. U.S. growth should, however, turn positive in the second half of this year spurred by expansionary fiscal and monetary policy. On the fiscal policy front, both the U.S. House of Representatives and Senate passed the $787-billion stimulus package, which President Obama signed into law. However, even with the mild recovery expected later this year, we anticipate the Fed will leave its target Fed Funds rate in the current 0% to 0.25% range as inflation decelerates and the Fed aims to ensure that the recovery picks up pace in 2010.

Initial jobless claims data continue to be disappointing

The news from the labour market continued to disappoint as weekly initial jobless claims remained at 627,000 for the second week in a row (the prior week's print was revised up from 623,000). Since this is the survey week for the labour market report, today's figure points to continuing weakness in the closely watched monthly report on net job losses.

RBC Financial Group

The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.