Economists say the Federal Reserve Board will move to cut U.S. interest rates after getting some negative economic news Friday. The question is how big the cut will be.

Those worried about deflation got some more ammunition with news that producer price inflation fell 0.3% in May. Core PPI was up 0.1%.

“U.S. PPI was a bond owner’s dream in May, although you can argue that bonds are already priced for perfection,” says BMO Nesbitt Burns. “Some one-off items in the core PPI led to a modest 0.1% rise. Everything else was down across the board. Headline PPI fell 0.3%, and the pipeline price indexes that led to worries earlier in the year have tipped over.”

CIBC World Markets says, apart from natural gas prices, “we are still in a world of deflation in goods prices.” It notes that price declines were seen in consumer goods like clothing, household appliances/equipment and pharmaceutical preps, as well as in capital equipment for manufacturing industries. “We continue to believe that the deflation risk — at least in terms of goods prices — is very much in play, even with a falling US dollar and its potential impact on import prices. In fact import prices excluding petroleum have declined for two straight months. There is nothing in this report to give Greenspan pause before delivering a rate cut at the next FOMC,” it says.

RBC Financial suggests that by year-end the weaker U.S. dollar will give a boost to PPI via higher import prices. Until then, producer prices will remain weak and may even fall some more, it says. “A Federal Reserve rate cut is likely at its next FOMC meeting on June 25 as it attempts to shore up the economy to prevent any deflation in the months to come from becoming entrenched.”

Nesbitt says, “This is pretty conclusive as far as it goes. If the Fed is worried about deflation, these figures suggest the choice should be the larger, 50-bp step. The real test, of course, will be core CPI.”

It was also reported that the U.S. trade deficit narrowed slightly in April to $42.03 billion following a downwardly revised deficit of $42.87 billion in March. “The fall of the trade deficit is likely to turn into a trend decline as U.S. consumers and businesses react to the change in the relative prices of exports and imports coming from the falling U.S. dollar,” RBC says.

In a separate release, the University of Michigan consumer sentiment survey dropped unexpectedly in June. The index came in at 87.2 for June, down from 92.1 in May.

“Although both components of the index declined, the main force was in the expectations component. With May’s downward revision, together with other indicators, does point to some near-term easing in confidence,” RBC says. “Given today’s tone in data, markets have already priced in a Fed cut on June 25, with the question now being how big the cut will be.”

PPI News release
http://www.bls.gov/news.release/ppi.nr0.htm