Consumer Price Index (CPI)
- What is the Consumer Price Index (CPI)?
- When is CPI released?
- How the CPI affects forex
- CPI trading strategy
- CPI example
- CPI takeaways for forex traders
What is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is an economic indicator that tracks the cost of goods and services and serves as an important statistic for identifying inflation or deflation. Known also as headline inflation, it is a major influencer of interest rate changes based on the inflation targets set by central banks.
The CPI figure is calculated by weighting the average price of a basket of products across goods and services such as groceries, transport costs, and healthcare, and measuring their change in price over time.
When the amount of the currency needed to buy the market basket increases, this is inflation, and when the amount of currency needed to buy the market basket decreases, this constitutes deflation.
The core CPI figure is slightly different as while it still measures the change in price of goods and services, it does not include energy and food prices. These are omitted for this measure as such prices have the tendency to be highly volatile and therefore capable of creating a misleading impression of inflationary pressures.
When is CPI released?
In the US, the CPI is released monthly by the US Bureau of Labor Statistics and has been reported since 1913. However, in countries such as Australia, the data is released on a quarterly basis, and in Germany, an annual report is issued.
How the CPI affects forex
Higher inflation in the form of a higher CPI naturally makes an individual unit of currency worth less, as there are more units of that currency needed to buy a given item.
High CPI may inspire interest rate hikes by a central bank in an attempt to control the inflationary trend. When a country’s interest rates are higher, it is likely that its currency will strengthen as demand for it increases.
Conversely, lower inflation may lead to decreased interest rates and weaker demand for a country’s currency, prompting consumers to spend, putting more money into circulation, and generally stimulating a slower economy.
So given this information, it’s no surprise that when CPI data is released, forex swings can happen in kind. Sometimes it can create volatile conditions with extreme movement, creating potential for large profits, as well as proportionate risks.
CPI trading strategy
The Consumer Price Index can move forex, which means there are numerous strategies for trading it.
To trade the CPI, you’ll need to be aware of the expectations the market holds for inflation and the likely outcomes for the currency if these expectations are met or missed.
Sometimes, an environment for increased inflation will be welcomed (for example, when deflation is rife), while in more inflationary conditions an increased rate of inflation may be considered bad for the economy.
Analyst expectations for inflation are released on a monthly basis, with their judgments based on supply and demand dynamics, currency prices, and key commodity prices, as well as fiscal and structural measures.
After the CPI release and surrounding analysis, you might want to bring in technical elements to your approach, examining if the price is reacting to key support and resistance levels. Technical indicators may help to give some insight into the short-term strength of the move, for more informed trading decisions.
However, as with other news releases, timing is everything. It may, therefore, be unwise to open a position shortly before an announcement, as forex spreads may widen substantially immediately before and after the report.
In the below chart, US inflation statistics are shown as a percentage of change since the same point 12 months ago. So, for the March 2021 figure, consumer prices were 2.6% higher than at the same point the previous year.
For US traders, the US Dollar Index (USDX), which shows the performance of USD against a basket of other currencies, can be a useful way of exploring the effects of CPI data. If the latest release is divorced from analyst expectations, traders may watch for USDX to move accordingly.
On the March 2021 CPI figures (which were released the following month), USD briefly spiked as the mark was slightly above analyst expectations. However, as it became clearer that interest rate hikes were likely off the agenda for 2021, the USDX fell, a slump aided by languishing US treasury yields.
CPI takeaways for forex traders
- CPI is a major indicator used for determining the rate of inflation
- The measure helps central banks to maintain price stability
- Significant forex swings can occur when releases don’t align with analysts’ expectations
- Time your entries carefully so as not to get caught by widening spreads
- Consider using other economic indicators in conjunction