The Consumer Price Index (CPI) has the important role in forex trading. It is an important economic indicator and CPI affects not only foreign exchange but also interest rates and stock and bond prices. CPI shows the complete and true picture of inflation. Consistent rise in CPI promises the assured economic growth. Inflation consistent rises resulting into growth. But if the CPI increases indefinitely and uncontrollably it reflects the declining growth because, the poor or common man cannot be able to afford the basic amenities that what the objective of CPI, it reveals about the reality of the Economy of any country.

The CPI is used to make changes in cash flow mechanisms such as pensions, health insurance and income. CPI is influencing many markets as a result; most traders and investors find it influencing their strategies in some way.

In this article we will inspect about what is CPI as a concept and what to consider when trading Forex against CPI data.

How does CPI Measures 

The market basket is nothing but the total amount of all goods and services available in the market. The CPI measures the price point change of this wholesale market basket, which includes 180 categories classified into 8 major super categories such as food and beverage, transport and health care etc, covering about 80,000 goods and services. This Index is calculated and determined by the Bureau of Labor Statistics.

CPI is calculated by dividing the average cost of the market basket in the current year by the cost of the market basket in the base year and multiplying the result with 100. This gives us the CPI of the current year. The calculation involved during this process of estimation of CPI is extremely difficult. This is because thousands of categories and sub-categories along with their ever-changing prices should be considered and classified into urban or rural consumption segments. CPI is the most important statistics for an economy as it measures inflation and gives us an idea of the cost of living. According to economic experts, CPI is considered as the benchmark inflation guide for a country’s economy.

Consumer Price Index = Market Basket of Desired Year/Market Basket of Base Year*100

Alternatively, the CPI can be performed as CPI = Updated Cost/Base Period Cost*100

The “updated cost” (i.e. the price of an item at a given year, e.g.: the price of bread in 2021) is divided by that of the initial year (the price of bread in 1970), then multiplied by one hundred.

When inflation is too low, a central bank like the Federal Reserve may cut interest rates in order to spur economic activity. When inflation is too high, interest rates may be raised to stabilize prices. By increasing interest rates, a consumer may be more likely inclined to save money, rather than spend it, due to the return they may generate by keeping it in a bank. In Forex monthly CPI measure is one of the most important indicators monitored by many traders.

How CPI Impacts Forex Market

The central bank wants to bring the economy to full employment and ensure a healthy inflation rate as the economy expands. As a result, Forex traders see both unemployment and inflation figures as figures dictating the central bank’s future decision to reduce, raise or maintain current interest rates. Traders can expect the impact of the interest rate on the strength or weakness of a currency to have an impact on the actions of the central bank and the impact of the dollar on currency pairs.

Forex traders consider the CPI and core CPI figures as the two most basic indicators of the performance of an economy. Between the two, however, the core CPI figure provides a better look at avoiding costs in the energy and food sectors, which experience higher price volatility over time. In the United States, the Department of Labor publishes CPI and core CPI figures that do not include energy or food costs in the measurement. If that number exceeds market expectations, the dollar will generally see gains against other currencies. However, if these readings fall short of consensus expectations, the currency will depreciate compared to other pairs.

However, its impact is not limited to the monthly report. Like all government data figures, the CPI figure is subject to revision by economists. Such changes can cause significant fluctuations in the value of a currency in the global market.

Conclusion

CPI gives a better glimpse of changes in the purchasing power of the consumer. While concluding this, It is worth to keep mind that most of the world’s major central banks target inflation. Therefore, the latest changes in CPI can give some clues, regarding the future path of the interest rates and monetary policy in general. For example, if in the given country the inflation rises well above the desired target, then the local Central Bank may respond with hiking interest rates and this can strengthen the currency. The second CPI effect on Forex usually takes more time to manifest. According to the Purchasing Power Parity, in the long term, currencies with low inflation tend to appreciate the ones with a higher rate of price level increases. This can be one way to explain the decline in the USD/CHF and USD/JPY in recent decades.