Consumer price index is calculated by assessing the changes in prices of each good and services in the sample basket of good and weighting them. The goods and services are weighted based on their importance. For example, a household’s expenditure on foods has more significance than entertainment expenditure. CPI is mostly representative of the changes in the cost of living, as it is one of the most prominent metrics used for identifying levels of inflation or deflation.
CPI’s Significance in the Forex Market
CPI, as a fundamental economic indicator, measures inflation levels in an economy. Since inflation has a direct relation with the economy’s currency, it has become one of the most important and closely tracked indicators for currency traders. Furthermore, CPI has a direct impact on the Forex market, as economic reports tend to result in significant movement in price action in the Forex market.
CPI is also known as headline inflation. This is due to its ability to track the level of inflation, cost of living, changes in aggregate wage levels, and ultimately determine price changes to reflect the market conditions for businesses. Since inflation has an inverse relationship with the real value of money or the purchasing power of money, central banks use it to determine inflation levels and try to control it through monetary policy, i.e. interest rates.
All of this makes the CPI data extremely important for Forex traders. It can provide the trader with insights into the government or central bank’s intentions of influencing the economy through monetary policy, especially when the information deviates from the government’s economic objectives.
So if the consumer price index is above the market’s expected number, it can, in most cases, leads to increase in value of the economy’s currency compared to other currencies. However, if the CPI is lower than the market’s expectations, then traders take that as a sign of weakness and an impending devaluation of the currency. Moreover, aside from deviations of the expected number causing shifts in market sentiment, revisions in the consumer price index also has a huge impact on the Forex market, as the new data provides fresh perspective on the market.
Due to all of these reasons, Core CPI and CPI are considered as the most observed fundamental indicators for Forex traders. One could even consider it an equivalent to P/E ratio in investment valuation for stock market investments, which is the most prominent fundamental financial indicator, distinguishing growth stocks from the rest. The Core CPI also has significance for Forex traders as it excludes highly volatile elements from the calculation such as food and energy goods and therefore better indicate the underlying the inflationary trend in an economy.
The CPI is considered as one of the most important indicators, as far as market movements and monetary policy is concerned. If you’re a Forex trader, consider assessing both fixed and chain-weighted consumer price index for better understanding of the Forex market.