The consumer price index (CPI) is a broad measure of inflation within an economy in relation to the prices of goods and services.
The CPI determines the weighted average of prices of a group of consumer goods and services, such as the price of transportation, energy, and food. For economists, the CPI is a tool that lets them evaluate the changes in individuals’ cost of living.
When the inflation is a bit low, the central bank such as the Federal Reserve may slash interest rates in order to stimulate economic activity.
When inflation becomes too high, the interest rates may be increased to let the prices stabilize. When the interest rates are higher, the consumer may more likely try to save money instead of save it, since they will be getting higher returns from the bank.
The CPI in the Forex Market
In the foreign exchange markets, the monthly CPI gauge is one of the most important indicators monitored by traders.
In the case of the US dollar, the publishing and revisions of the CPI figure from the Bureau of Labor Statistics can move prices and spur swings in the currencies’ value against other currencies.
Importance to Forex Traders
The forex markets usually called the CPI as the headline inflation. This CPI data is crucial in the currency markets since inflation dramatically affects the decision made by the central banks in relation to the monetary supply.
And because central banks usually have a mandate to control inflation at a suitable level, the makers of the policies increase or decrease rates as a medium of reaching these target levels. The Bank of Japan and the Federal Reserve have historically targeted inflation levels of 2.0%.
The central bank may also introduce other policy recommendations such as bond-buying agreements or the expansion of the money-supply.
Should inflation levels veer above the target levels, it may precede the central bank’s move to raise interest rates to cool down spending and the economy.
This will strengthen the US dollar against other currencies as higher rates make the dollar more appealing.
It is also a forward indicator of an economy’s performance. If the inflation rate rises steeply, consumers will be less likely to save money as their buying power diminishes.
On the flipside, when the central bank increases interest rate, borrowing by individuals or by businesses will typically decrease. And that can affect the broader gross domestic product of a nation.
Effects to the Dollar
The Federal Reserve holds a dual mandate that affects its actions on monetary policy. The central bank has to bring the economy to full employment, and it also wants to guarantee a healthy rate of inflation as the economy expands.
As a consequence, forex traders see both the unemployment and inflation data as figures that will move the central bank’s future decision—to cut, to raise, or not to do anything at all.
Because of the impact of an interest on the strength of weakness of a currency, traders can predict the impact of the central bank’s actions and the impact on the dollar’s performance in currency pairs.