The Consumer Price Index or CPI is a fundamental economic indicator that has become one of the most closely watched inflation measures used by forex traders. Furthermore, both the influential data’s initial release and its subsequent revisions can often result in significant swings in the forex market.
The level of the CPI is commonly used by economists and fundamental traders to assess the level of inflation prevailing in a country’s economy that relates to the cost of goods and services to a typical consumer.
Sometimes also known as “headline inflation”, the CPI data is often used to compute cost of living increases in wages and to determine suitable price increases for goods and contracts by businesses.
Since inflation tends to result in a decrease in the purchasing power of money in an economy, many central banks have as their primary mandate the controlling of inflation within acceptable levels. Central banks typically do this by raising interest rates to combat higher inflation, and lowering interest rates in deflationary situations.
This makes the CPI data especially important to forex traders since it can influence a nation’s monetary policy, especially when it deviates from its normal values.
The CPI Indicator and What it Measures
The Consumer Price Index indicator is a weighted average of the price changes seen in a certain basket of consumer services and goods. The weights for each item are determined based on the item’s importance in the economy. The index usually includes items such as: food, transportation, housing, recreation, medical care, clothing, and education.
Furthermore, Core CPI in the United States excludes the more volatile price changes in food and energy commodities since their price fluctuations can obscure the underlying trend in inflation. Both the Federal Reserve Bank and forex traders tend to focus on this less volatile number to assess inflationary pressures within the U.S. economy.
Both the CPI and Core CPI is typically expressed on a monthly percentage change basis in the United States. In addition, the data for each month is released between the 13th and 19th of the following month by the U.S. Department of Labor.
The Economic Impact of Changes in the CPI
The changes seen in the CPI can have a large effect on an economy. When the CPI of an economy is rising strongly, it tends to discourage consumers from saving and reduces their purchasing power.
Also, benchmark interest rates tend to increase in a rising CPI environment as central banks move to fight inflationary pressures. This results in a contraction in borrowing for expansion purposes.
On the other hand, a declining CPI that is typical of deflationary periods tends to signal an economic slowdown in a country. Benchmark interest rates set by central banks also usually come down during such low or negative inflationary periods in order to make borrowing less costly.
How the CPI Data Affects the Forex Market
Basically, if the CPI or Core CPI number for a country comes out above the market’s expectations, then that tends to increase the value of that country’s currency relative to other currencies.
On the other hand, if the CPI or Core CPI comes out below the market’s expectations, then that will tend to reduce the value of that country’s currency relative to others.
In addition to deviations of the most recent number from expectations causing forex market volatility, revisions to previous numbers can also have a significant market impact.
The CPI and Core CPI are some of the most closely observed of all of the fundamental indicators for an economy. Nevertheless, the forex market tends to focus on the Core CPI data for a country, if available, since it tends to better indicate the underlying trend in inflation by excluding the especially volatile of food and energy elements.