- Inflation signals a rise in consumer prices, decreasing the value of money.
- The Consumer Price Index measures the price change of a basket of essential goods, including food and energy.
- Economists measure different types of inflation, most notably cost-push inflation, demand-pull inflation, and built-in inflation.
- CPI is a widely used and recognized Forex indicator to measure currency inflation.
- When CPI data overperforms forecasts, the currency usually gains a bullish momentum.
- When CPI readings underperform forecasts, the currency may gain a bearish momentum.
Forex traders have to know the value of money. Any sudden change in inflation or new information coming to light could potentially change a currency’s price. Forex traders use the Consumer Price Index in the fundamental analysis to keep tabs on the price changes and conducting fundamental analysis, which is released monthly or quarterly, depending on the country. The Consumer Price Index is a major indicator of an economy’s overall performance. Investors can anticipate a sudden price swing in currency pairs following a CPI release. The index describes a change in inflation, buying power, and consumer behaviour. Staying in tune with inflation helps traders pocket more profits, hedge their bets, and minimize their losses.
What is inflation?
Inflation is a term used to describe a drop in value. In Forex trading, the term inflation is tied to the value of money. When inflation rises, the value of money decreases, and consumers can buy fewer goods for the same price. Inflation is considered a problem if it’s too high or too low. Monetary banks usually aim to maintain steady inflation of 2%, which signals that the industry is working well and that consumers are effectively buying goods and services. When inflation is too low, central banks pump more cash into the system to stimulate the economy. When inflation is too high, central banks raise interest rates to deflate the economy and increase the value of money. Inflation rates have different meanings depending on the state of an economy. Sometimes, rising inflation triggers Forex traders into buying more currency because the rising inflation signals that monetary policies are warming up the economy. More money is being distributed, and people can buy more goods, services, and properties. At other times, rising inflation can trigger an avalanche of sell orders, urging Forex traders to short a currency.
Three types of inflation:
- Cost-Push Inflation: costs of manufacturing goods and services increases, with no other alternative.
- Demand-Pull Inflation: demand outgrows supply and causes the deflation of goods, which reduces the value of money. DPI is often described as “more money chasing fewer goods.”
- Built-In inflation: persistent inflation from past events affects current inflation rates.
What is the Consumer Price Index?
Forex traders keep an eye on the CPI index as it signals the next buying, selling, and hedging opportunity. The Consumer Price Index is a market-moving indicator reporting on general inflation and pricing pressure. The CPI measures an average change in urban price for a basket of goods and services, including food and energy. Both food and energy is excluded from the core inflation readings. Energy and food prices are volatile and heavily dependent on political headlines, so economists can better understand the market with a more stable consumer basket. The CPI is the most widely watched indicator for the USD inflation rate. The index is developed through interviews and surveys with the urban workforce. Roughly 24,000 urban consumers share their spending habits with the Bureau of Labour Statistics (BLS) every quarter, helping determine the change in prices compared to the previous period. The process is different for each economy, but most major economies share CPI readings with the public. Any change in the CPI can strengthen or weaken the currency and impact the global performance of international companies.
How does CPI affect Forex strategy?
The Bureau of Labour Statistics publishes monthly changes in the Consumer Price Index, usually before the 15th of the upcoming month. If the CPI rate is higher than anticipated, it signals higher inflation, the USD increases in value. Conversely, USD may drop in value against other currencies if the announced CPI rate is below market anticipation. The Consumer Price Index for January 2021 was 1.4%, which is 0.01% less than the forecasted 1.5%. The AUD/USD pair instantly rose, setting a new trend and taking the Australian Dollar from $0.77422 to a psychological resistance of $0.8000 in the following weeks. The CPI inflation can strongly influence price movements, but it’s not a standalone indicator of price changes and should be used as a part of a larger fundamental strategy. The CPI is not a strategy in and of itself. Many other factors are at play in every fundamental strategy, including extreme weather catastrophes, political elections, global accidents, and other financial markets. Central banks maintain low levels of inflation, with most governments setting target goals for the year. Most central banks have a similar target when it comes to current inflation. The Federal Reserve, The Bank of England, and The Reserve Bank of Australia target yearly inflation between 2% and 3%. Index CPI is usually released monthly, with individual countries choosing to release data every quarter. Germany even offers a yearly overview together with monthly data.
CPI release dates for major economies
- Australia: Quarterly
- New Zealand: Quarterly
- Canada: Monthly
- Germany: Monthly, yearly
- China: Monthly
- Eurozone: Bi-monthly
- Japan: Monthly
- United States: Monthly
- United Kingdom: Monthly
The CPI, Forex, and Inflation
Forex traders use Inflation rates and the Consumer Price Index as vital indicators in fundamental analysis. The CPI measures change in consumer goods’ prices over time, referencing a basket of goods that represents a standard of living in a given country. Forex traders follow the difference in the forecasted CPI inflation and the announced rate. When the CPI inflation is higher than the anticipated rate that can signal bullish momentum for Forex traders. Conversely, underperforming CPI signals weaker inflation and a potential for bearish momentum for the currency.