The Consumer Price Index (CPI) Indicator and the Forex Market

The Consumer Price Index (CPI) often grabs headlines in the news, especially during times of rising prices.  It’s one of the major economic indicators that economists and politicians alike scrutinize for any signs of impending inflationary pressures.

Investors in almost every single investment market also rely on the monthly Consumer Price Index figures to gauge or predict market movement.  The Forex market is no different; Forex traders (especially long-term traders) focus on this economic indictor to make their trade decisions.

So what’s the big fuss?

So why is the CPI the granddaddy of all economic indicators?  It’s because it measures average prices for common goods and services (i.e. eggs, milk, transportation costs, utility costs) purchased by households across the country, and then compares those numbers to previous figures. Those price changes in the CPI are an economy’s measure of inflation.

If inflationary pressures start to rise, then interest rates rise, which in turn can negatively affect a country’s exchange rate if inflation continues to increase.  If, on the other hand, prices don’t rise at the same level of other countries, then that country’s currency rate rises compared to other currencies.

Calculating the CPI

The CPI is calculated by taking the weighted average of a particular good or service and multiplying it buy its price, and then dividing it by the weighted price of a previous period.

The weighted average figure that’s used in the formula is a percentage of the total amount of expenditures of all goods and services included in the CPI.  Once the CPI is calculated, then it’s matched against previous figures to obtain any percentage changes.

Price jump in one area can affect other prices in index

Price jumps of certain goods and services can have a real strong affect on prices on other goods and services.  Take the case of gas – if the price of gas goes up 10% in two months, then that affects prices for other goods such as heating and transportation costs, which are highly dependent upon gasoline prices.  In no time at all, inflation develops in the economy, due to a single, original price jump.

The goal of a Forex trader, therefore, is to monitor CPI figures for any price hikes in one commodity that can have an influe