CPI: How Inflation Data Affects Currencies

The Consumer price index is a crucial element for the economy as inflation is an important topic that central banks try controlling. Prices can make central banks to raise or cut interest rates; it can also push currencies down or up, or even can make you feel that everything will be fine, or will go badly.

With that in mind, traders around the world spend hours learning the secrets of economic events, including how to discern inflation data and how CPI can affect the value of a given currency. Why? Simple, they want to make money when the CPI numbers are released.

Today, we are going to talk about the consumer price index and how to trade the inflation data. So, let’s begin with the basis of CPI and forex trading. 

What is CPI

The Consumer Price Index, better known as the CPI or the inflation data, is an essential economic indicator published every month. It measures the value of prices of a basket of consumer goods and services and the change it experiences between two or more given periods.

The changes in the price data are used to find the cost of living and how much money people need to live. So changes can also represent how poorer or richer is a person regarding its purchasing power and the differences with other periods of time.

The CPI is widely used as an indicator of the health of a given economy. It also measures inflation or deflation and how prices synergies are working in a country.

The basket of goods and services that build the consumer price index includes the eight major sector groups in an economy. Housing, transportation, medical care, recreation, education and communication, apparel, food and beverage, and other goods and services are represented in the index.

In the United States, the Bureau of Labor Statistics records prices of about 80,000 items each month in service establishments, retail stores, and other offices across the country.

It is calculated as follows:

CPI= Cost of Market Basket in Base Year / Cost of Market Basket in Given Year X 100

There are two numbers for CPI, the CPI-W, for urban earners and clerical workers, and the CPI-U for urban consumers. It is also released as the regular CPI for all goods and services but also the CPI ex-food and ex-energy, to avoid top volatility goods. Regular Consumer Price Index is known as Core CPI.

What is Consumer Price Index ex Food and Energy and why it matters

The Consumer Price Index Ex Food and Energy is similar to CPI, but it excludes food and energy prices. Those two sectors are volatile and non-systemic products, so the BLS excludes it to capture a more accurate calculation that excludes the big swing food and energy can perform suddenly.

In terms of trading, the consumer price index, excluding food and energy, has more impact in the forex market than the core CPI. Also, annual CPI is more followed than the monthly CPI.

CPI and Forex: How inflation data affects currencies

After answering what the consumer price index is, let’s talk about how CPI moves currencies and affect the Forex market.

First, let’s say that inflation is a natural symptom of a healthy economy. While increasing prices are good for the economy, high or extreme inflation is bad. On the contrary, deflation, which is the decline in the CPI is even most dangerous.

Inflation is controlled and managed by central banks, and usually, they have a 2.0% annual inflation target. In other words, central bankers want inflation to rise at a 2.0% rate every year.

That being said, when inflation is too low, central banks cut interest rate to fuel economic activity. On the other hand, when CPI is too high, interest rates are usually raised to stabilize prices.

As you may know it, a higher interest rate influence the increase of the value of a currency. Also, a lower interest rate pushes the money of the given country down.

In the forex market, traders follow the CPI data every month because it can anticipate what the central bank will do in terms of interest rates. It also can anticipate consumer trends.

Most important CPI releases in the world:

From America to Asia, there are countries with releases that have more impact on Forex than others. Here, a list of the most critical consumer price index releases in the world.

How to trade CPI data

In Forex, traders open positions to take advantage of the changes in the valuation between two currencies. As fundamental and economic events are a source of volatility, traders follow data.

However, the difference is that as a trader, we don’t trade the number itself, but the difference between the expected number and the actual value. Also, any notion that the data could give us for strengthening or weakening of an economy.

That being said, and generally speaking, a higher than expected consumer price index tends to push the currency of the country to the upside, so it is seen as bullish or positive. On the other hand, a lower than expected CPI tends to push the money down, so it is negative for the currency.

Also, it is all about interest rates. If inflation is too high or above expectations, the central bank would think about raising rates so that the currency will go up. However, if the inflation is too weak, or even deflation is experienced, the central bank will be in a hurry to cut rates; sending the currency down.