Consumer Price Index (CPI) In Forex Trading
Consumer price index (CPI) is a measure of inflation within a region that calculates the average change in the cost of goods and services.
A consistent set of metrics is used when calculating CPI, including – Transport, energy, food, housing, medical care, education, and recreational spending.
Now that the basic definition is over and done with, it’s time to put our trading hats on and examine the relevance of CPI in the Forex market.
Why is CPI important?
As mentioned, the consumer price index is an excellent gauge of inflation. As a result, changes in CPI have a major impact on economic activity.
When CPI increases, consumers are less likely to save money as prices could go even higher. This also leads to a decrease in consumer purchasing power because most services and products are more costly.
To ensure inflation does not get out of hand, central banks will usually hike interest rates to reduce inflationary pressure. This makes borrowing the currency more expensive but helps control the cost of goods and services.
When CPI decreases, consumers are discouraged from spending money because prices will likely go even lower. Resultingly, people begin to save their money instead of using it now.
To prevent deflationary pressures, the central bank will likely cut interest rates to encourage borrowing and spending.
But what does all of this mean to you as a Forex trader?
Affect on currency prices
Let’s break this down step by step:
- CPI indicates the level of inflation.
- Inflation is one of the main factors central banks use when making interest rate decisions.
- Interest rates determine currency valuations.
- Thus changes in CPI directly impact the relevant region’s currency and the Forex market as a whole.
Suppose the consumer price index data is consistently high. In that case, this will likely lead to an interest rate hike which is bullish i.e. the currency would appreciate against its peers.
Suppose the consumer price index data is consistently low. In that case, this will likely lead to an interest rate cut which is bearish i.e. the currency would depreciate against its peers.
Where can you find consumer price index data?
Effect of the release itself
Up to this point, we have discussed the importance and medium to the long-term impact of CPI on market movements. But how do participants react to the news event alone?
Traders care about the relationship between the expected outcome and the actual result:
- If the actual and expected numbers are the same or similar, there usually isn’t much volatility.
- If the actual release is worse than expected, this usually results in a sell-off (decline in value).
- If the actual release beats estimates, this usually results in buying (appreciation in value).
Keep this in mind the next time you are trading near to, or after, this news event.
Consumer price index carries differing levels of significance depending on an individual’s trading approach. But regardless, this economic indicator has weight in both the short and long term, so make sure you are on the right side.
May the market be with you.
Consumer Price Index FAQ
Consumer price index (CPI) is a measure of inflation within a region that calculates the average change in the cost of goods and services. A consistent set of metrics is used when calculating CPI, including – Transport, energy, food, housing, medical care, education, and recreational spending.
Central banks focus on inflation and employment data when making interest rate decisions. Since CPI is the headline inflation number, it has a massive effect on markets.
A higher than expected CPI figure is ordinarily bullish for a currency. A lower than anticipated CPI figure is ordinarily bearish for a currency.