The consumer price index measures the average price development of all goods and services that private households buy for consumption purposes. This includes, for example, food, clothing, and motor vehicles, as well as rent, cleaning services, or repairs. All expenditures are taken into account, i.e., in addition to the expenditures of, for example, single households, married couples, families, or retired couples, the expenditures of foreign tourists are also taken into account.
The change in the consumer price index compared to the same month of the previous year or the previous year is colloquially referred to as the inflation rate.
The consumer price index is the central indicator for assessing monetary value development and is used as a benchmark in wage negotiations or in contractual agreements on the number of recurring payments (so-called value maintenance clauses). It is also used for deflation in national accounts, for example, when calculating real economic growth.
Importance of CPI for currency traders
The development of the inflation rate and thus the consumer price index is important for forex trading. If inflation rises, purchasing power and thus consumption decrease. This causes a country’s currency to weaken.
If inflation decreases in another country, i.e. purchasing power increases, this leads to an appreciation of the currency. This can now have an impact on the exchange rate of the currencies of the two countries.
The consumer price index is published by the country-specific statistical office as a press release. Shortly before the end of the month comes the forecast and then in the new month the actual development of consumer prices.
Interpretation of the CPI published figures
For a currency, the only thing that matters is the interest rate level. The higher the interest rate in a stable economy, the more attractive the currency becomes.
Therefore, traders specializing in interpreting economic data control economic releases between meetings of the central banks. Based on the results, they expect an increase or decrease in the interest rate or a decision not to make any changes at the next central bank meeting.
At the center of the agenda is inflation. Central banks strive to fulfill their mandate and will adjust interest rates to reflect changes in inflation.
But not all inflation data leads to the same market reaction. For example, the publication of the CPI is not as important as the “pure” CPI.
The “pure” Consumer Price Index (CPI) takes into account changes in the prices of goods and services, with the exception of transport and energy prices, as they are considered volatile and distorting data.
This is an economic release that will cause changes in the monetary policy of central banks. Thus, traders should focus on how much the CPI is off target and, if it is off target, adjust their trades according to what decision central banks are likely to make.
In addition to the primary data, there is another element that affects inflation – the price of oil.
Oil, or its price, has a robust inflationary component. Transportation and energy prices cause the general price level in the economy to move up or down.
Thus, currency traders should always keep an eye on oil prices. Like it or not, central banks cut or raise interest rates, depending on whether the price of oil rises or falls.
While some traders give a lot of value to the CPI data, experienced traders keep an eye on oil prices and market drivers. Data such as the level of production and reserves, geopolitical transactions in the oil market, and decisions of OPEC (Organization of Petroleum Exporting Countries) affect the price of oil and global inflation.
For this reason, the “net” CPI is a crucial indicator of inflation, and it should also matter to currency traders.