Most of the best Forex books often talk about CPI, but are you sure that you know what is it? The Consumer Price Index, also known as CPI, is an indicator that aims to calculate the inflation rate of an economy based on the price of their goods and services. The results this indicator generates can have a big impact on the price of a specific currency when compared to other world’s currencies, which makes savvy investors keep an eye on them as they are released. .
To analyze this data, the CPI uses the regular value of a basket of consumer goods and services, including mobilization, food and energy costs. In order to evaluate the variations in the prices of people’s cost of living, economists use the figures produced by the CPI.
Inflation levels affect directly the interest rates of every country and the prices of their every product as well . When inflation levels are too high, the interest rates are likely to increase as a measure to stabilize market prices; by executing this action, consumers may be prone to put aside money, instead of spend it, because of the interest rate they could receive if the money is left in a bank account. However, if the inflation levels are too low, central banks can reduce the interest rates as a measure to increase economic activities and market transactions overall.
The monthly CPI measure is one of the main indicators checked by traders in the financial markets and highlighted in the best Forex books. When the Bureau of Labor Statistics publishes the CPI figure of the U.S. dollar, the probability of changes in the value of the U.S. dollar in relation to other currencies are very high. Almost sure, since it affects directly the people’s cost of living one way or another.
The importance of CPI to Currency Traders
The CPI indicator is also known as “headline inflation”, and it plays an important role in the currency markets since central banks’ decisions regarding monetary policy are greatly influenced by inflation.
The Central bank’ duties include maintaining inflation at a bearable specific level. The Federal Reserve and the Bank of Japan aims to achieve an annual inflation rate of 2.0%. Policy makers manipulate interest rates accordingly with the goal of making this rate happen. Other mechanisms, such as bond-purchasing agreements and the expansion of the money supply might be suggested and implemented as well in order to meet the end.
Central banks, such as the Federal Reserve, change interest rates if inflation is not within targeted levels, they have the right and even obligation to do it. For example, if inflation is higher than 2.0 %, the Fed may increase interest rates to slow it down. This measure will make the dollar more attractive and strengthen it against other currencies, encouraging saving.
The CPI shows in advance how an economy is doing. If inflation increases at an accelerated rate as Brazil or Venezuela have recently, people will tend to spend more money since their purchasing power is decimated almost daily. Or buying stronger currencies, usually USD or EUR.
People and businesses tend to be less interested in borrowing money from a bank for inventory, services or business growth when a central bank decides to raise interest rates. This factor has an impact on the broader gross domestic product of a nation.
How CPI Data Affects the Dollar on the Forex Market
Now, one of the central bank purposes for this period is to take the economy to full employment, as well as making sure there is a steady and conscious inflation rate during the economy growing process. For this matter, Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, also aims to reach a 2.0% inflation rate on behalf of the Federal Reserve.
As Joe Ross, the creator of best Forex books bestsellers, highlighted: for this reason, many forex traders see inflation and unemployment index as indicators of how the central bank takes its decisions, whether it is to keep, increase or reduce the interest rate levels. Why? Because traders can predict the effects of both the central bank decisions and the behavior of the dollar in relation to other currency pairs and the global economy. When evaluating how an interest rate affects a currency pair, having the CPI nearby definitely gives us a hand when predicting future movements.
Forex traders see the CPI and Core CPI figures are two of the most reliable indicators to predict the behavior of a specific economy. The Core CPI figures is the one that offers more useful information, because of the values it takes into account when evaluating data. For example, when publishing the CPI and Core CPI figures, the Labor Department skips adding to the account the energy and food costs in the Core CPI figures, as their volatility makes them unpredictable over time.
The effect of this indicators is not only restricted to monthly reports. Economists actively analyze these figures, since this type of changes can make a lot of difference in the international market on both short and long term trades.
The CPI is an invaluable indicator for the economies and the inflation material, which is a great aid for traders. Both Forex traders and companies highly rely on the changes the CPI figures, because of the benefits that this information brings to the table in order to make accurate predictions.