What is the Consumer Price Index or Inflation (CPI) in the Forex Economic Calendar?

What is (CPI) Inflation?

As its name suggests, the calculation of this index is from the final consumer's pov, that is, the ordinary citizen who buys his daily needs from a grocery store or local market. The Consumer Price Index or CPI is the average price of purchased goods and services such as toothpaste, milk, groceries, gas, etc. But instead of a simple average, according to the number of goods and services used among the target community, a certain weight is assigned to each good and service. For example, milk, which is a daily requirement of many consumers, will have a higher weight in the average price calculation than furniture that we do not buy daily or frequently. Also, when we say commonly purchased goods and services, it includes a wide range of goods and services (over 80,000), and rarely purchased items such as stocks, bonds, foreign investments, or Real estate is not included.

How is CPI Calculated?

The Bureau of Labor Statistics (BLS) examines the prices of 80,000 consumer goods to create this index and publishes it monthly. The consumer price index has two subcategories. One is CPI-W, which means "Consumer Price Index for Urban Wage Earners and Clerical Workers." CPI-W statistics are released first, and CPI-U (Consumer Price Index for All Urban Consumers) values are released later. CPI-U is a broader statistic in terms of the target population and coverage of goods and services.

The CPI-U is a more accurate and complete statistic than the urban population, which covers about 93% of the US population, while CPI-W covers only about 29%. This list includes food, clothing, fuel, transportation fare, service charges (water and sewerage services), etc.

The consumer price index is declared as a percentage change compared to the previous number, which can be monthly, quarterly, or annually.

Consumer price index = average cost of selected goods and services for a specific period / average cost of selected goods and services for the base period (usually the previous period) * 100

Why is CPI Important?

The importance of the consumer price index has several aspects. The first is the scope and history of the data. With such a huge data set, reliability is very high and usually depicts the macroeconomic picture of a country. For example, the history of CPIAUCSL (Consumer Price Index for All Urban Consumers) goes back to 1947.

The second is the frequency and statistical nature of these data. The CPI is a true reflection of the current economic situation facing the end consumer or citizen.

Third, changes in the CPI help determine changes in retail prices related to a country's cost of living. Hence, it is widely used to evaluate inflation. In this index, there are many subcategories where certain goods and services are removed from the basket of goods and services to provide a more accurate picture of inflation in absolute or relative terms. For example, Core CPI removes food, gas, and oil prices from the equation because these items' prices are relatively volatile.

How can the consumer price index be used to analyze markets?

Due to the diversity in statistics, economists of different tendencies can discern and use the consumer price index for their goals. For example, the US Bureau of Labor Statistics also provides indicators based on different geographic regions. Also, CPI is a widely used index to measure inflation. The CPI can be considered a regulator for other economic indicators, such as hourly wages and the value of the domestic currency (Buying capacity of dollars to provide goods and services). On average, for a developed country like the United States, a 0.2-0.5% increase in the CPI is standard, and any numbers beyond these numbers usually indicate sharp swings in economic growth in either direction.

The CPI Relationship With Interest Rates

The CPI's most significant effect on the forex market is its influence on interest rates. Central banks use CPI to determine monetary policy, and interest rates are the main tool central banks use to control inflation. When inflation is high, central banks tend to raise interest rates to reduce demand for goods and services, which can lead to lower prices. Conversely, central banks tend to lower interest rates to stimulate demand and increase prices when inflation is low.

Higher interest rates attract foreign investors to a country because they can earn a higher return on their investment. This increase in demand for a currency can lead to a rise in its value. Conversely, a decrease in interest rates tends to decrease the demand for a currency, which can lead to a drop in its value.

For example, the Federal Reserve may raise interest rates to keep inflation under control if the CPI rises in the United States. Higher interest rates can attract foreign investors to the US dollar, which can cause an increase in its value. On the other hand, if CPI falls in the Eurozone, the European Central Bank may cut interest rates to stimulate the economy. A decrease in interest rates can reduce the demand for the euro, which can cause a drop in its value.

Read More: The Federal Reserve interest rates effect on Forex Trading

The CPI Relationship with Central Bank Policy

CPI also plays a significant role in central bank policy. Central banks set monetary policies based on their inflation targets, and the CPI is a vital indicator for achieving these targets. If the CPI is higher than the central bank's target, they may act to reduce inflation. Conversely, if the CPI is lower than the central bank's target, it may work to increase inflation.

Central bank actions can have a significant impact on forex markets. For example, if the Bank of Japan decides to increase its monetary stimulus, it could cause a decrease in the Yen value. That is because an increase in monetary stimulus can cause an increase in the money supply, which can devalue a currency.

The CPI Relationship with Exports

CPI can also affect the forex market through exports. When the CPI is high, the cost price of goods and services increases, which can lead to a decrease in exports. Because higher prices can make a country's exports less competitive in the world market. Conversely, when the CPI is low, the cost of goods and services will fall, which can lead to an increase in exports.

For example, if the CPI increases in Canada, it can lead to a decrease in exports, as Canadian goods and services become more expensive in the world market, and it can cause a decline in demand for the Canadian dollar, which in turn leads to a drop in its value.

How CPI affects the price of forex currency pairs after the news release

In this part of the article, we will analyze the impact of the Consumer Price Index (CPI) on a currency at its announcement time and see where the market will end up. The image below shows that CPI data impact the target currency (red square indicates high impact), which means it can cause extreme volatility after the news is announced. Ideally, when the actual CPI numbers are higher than the forecast, it will cause the target currency to grow and vice versa.

Let's assume that the latest Australian CPI data, which is quarterly, has been released. Seasonal data is more important and influential than monthly numbers. The image below shows the fourth quarter CPI data, measured in January, and the next quarter's data will release in April. Below, we can see that the CPI data for the fourth quarter was 0.7%, which is 0.2% higher than the previous reading. Also, it is 0.1% more than the predicted figure. However, let's see how the market reacted to the data.

You can see the previous, forecast, actual value, and the latest Australian inflation data's release date in the image below.

 

You can see the Australian dollar to the US dollar (AUDUSD) currency pair's chart before the announcement in the image below.

 

The image above shows the AUD/USD chart, where we can see that the market is in an uptrend, which shows the strength of the Australian dollar. One of the reasons behind the bullish trend is that traders and investors expect a 0.1% increase from the CPI data. If the CPI numbers rise more than the "Australian Bureau of Statistics" expects, it could be the best scenario for a "buy trade" in the market. However, if the numbers are lower than expected, volatility can increase to the downside.

Below, you can see the Australian dollar to the US dollar (AUDUSD) currency pair's chart after the news announcement.

 

Here, we see a sudden spike in volatility to the upside after the announcement. The reason for this is the 0.2% increase in CPI, which the market expected to increase by 0.1%. The large green candlestick shows how much the CPI data affect the currency's value. From a trading viewpoint, one should not enter the position immediately but wait for the price correction in the nearest support area and then make appropriate decisions. The CPI data for the Australian dollar was so positive that the price did not even break below the moving average. The "profit target" for the trade can be at the new "top" with a stop loss below the opening price of the candlestick.

You can see the Australian dollar to the Canadian dollar (AUDCAD) currency pair's chart efore the announcement in the image below.

 

You can see the Australian dollar to Canadian dollar (AUDCAD) exchange rate chart after the announcement in the image below.

 

The AUD/CAD currency pair seems to be at the bottom of a "subway range" just before the announcement. An interesting way to position this currency pair is to have small "buy" positions before the news release. Because the forecasted CPI data is higher than the previous reading, we are at a significant technical level that supports our "buy" positions. The news result makes the "Support" area work beautifully as the market moves upward into the resistance area. The data was very positive here for the Australian dollar as higher CPI data raised the currency. Even if the price is below the "resistance" area, we can maintain our trades, because the news data is great for the currency, and it has the potential to break the "resistance" and move further.

You can see the European Union Euro to Australian Dollar (EURAUD) currency pair's chart before the announcement below.

 

You can see the European Union Euro to Australian Dollar (EURAUD) currency pair's chart after the announcement in the image below.

 

In this currency pair, the Australian dollar is on the right side, which means that positive Australian CPI data should cause the currency pair to fall. We see that the Australian dollar is now strong as the market is in a bearish trend, and market participants are optimistic about the Australian CPI data. After the CPI announcement, volatility increases to the downside, pushing the price into a new "price valley." Again, when we see better-than-expected numbers from any economic indicator, we should not rush into trading, but wait for the price to return to key levels. In this case, since we don't see a correction after the "red news candle," only aggressive traders can take "sell" positions, confident that the CPI numbers will be much better than before and the currency pair's price will fall.

How CPI or US inflation affects the dollar and other Forex currencies

The economy of most countries in the world somehow depends on the world's largest economy, the United States, and the dollar's value, so one of the most important inflation data is the economic calendar related to the United States, which causes fluctuations in many currencies and goods other than the dollar, such as the euro, yen, gold, oil, etc. Further, we will review the latest inflation data published since June 12, 2023. Note that one of the major and volatile data of the economic calendar is inflation, so you must observe capital management during publication.

In the image below, you can see the previous, forecast, and actual, US inflation data in the economic calendar of the Trendo application.

 

As you can see in the picture above, several inflation data of different types and times for the US were published in Trendo's economic calendar. The data marked in red next to them indicate higher importance. The three zoomed inflation data are more important than the data size. Also, the Core CPI data is the most important in the monthly, and then the CPI in the annual aspect, so analysts categorize the data in terms of importance when releasing the data.
The Core CPI data was published as expected at 0.4%, the annual CPI published at 4%, 0.1% lower than expected, and the previous one was 4.9%. The monthly CPI data was also lower than expected, and the previous one was published at 0.1%.

Since the data was a little lower than expected, we can expect a decrease in the dollar's value in the graphs, so we will see how the result of inflation has affected the charts.

You can see the European Union Euro to US Dollar (EURUSD) currency pair's chart after the announcement in the image below.

 

In the picture above, you can see the Euro to Dollar chart in the 30-minute time frame. Before the release of the news, several bearish candles formed, but after the news release, which indicated a decrease in inflation according to expectations, a long green candle formed in the direction of reducing the dollar's strength according to the news results. But then the trend indicative of the initial excitement at the time of the news release has returned and decreased, meaning, the dollar has strengthened against the news result. This decline, contrary to expectations, could be due to various reasons. For example, it is possible that the chart failed to cross the resistance area due to technical analysis and had a fall, or because the inflation data was published close to the market's expectations, probably this result was included in the currency pair's price before the news.

Therefore, to use the results of the economic evaluation news, several factors such as technical analysis and checking the status of the desired currency before the news release, and paying attention to the small details of the published data, so we can better analyze the news results. Also, news review does not have a general approach and should be reviewed according to currency and market conditions, it may differ in different situations of news analysis.

You can see the US dollar to the Japanese yen (USDJPY) currency pair's chart after the news announcement in the image below.

 

But in the 30-minute dollar-yen chart before the news release, unlike the euro-dollar chart, the US dollar has weakened, and this currency pair has fallen. After the release of the inflation news, a bearish candlestick formed, but with a very long shadow. This very long shadow can be due to the high trading volume and high fluctuations at the time of inflation news release. This candle shows that in the first seconds of the news, the dollar strengthened due to the high trading volume, but then because of the published news result, i.e., the decrease in inflation, the US dollar also weakened. But after the initial excitement of the news, due to various reasons mentioned in the Euro-dollar example, the dollar has strengthened, and this currency pair has taken an ascending path.

Note that the dollar-yen currency pair is one of the most volatile currency pairs at the time of the economic calendar news release related to the dollar.

In the picture below, you can see the gold (XAUUSD) chart after the announcement.

 

Gold's 30-minute chart at the time of the news release has formed an almost doji candle with long shadows above and below. This candle shadow in the 30-minute time frame can be seen more accurately in lower time frames such as 5 and 1 minute. After checking, it was found that the candle's lower shadow formed first and then the upper shadow. Therefore, we can conclude that in the first seconds and minutes of the news release, due to the high sentiments, the dollar strengthened first, but then with the news result, the dollar weakened, and in the final minutes, due to the reasons mentioned in the Euro-Dollar example, the dollar strengthened, and this strengthening has continued.

Trading Strategies in Forex

Now that we understand the importance of CPI to Forex traders, let's explore how to trade CPI in Forex. There are two main ways to trade CPI:

1. Trading currency pairs of countries with high CPI:

One way to trade with CPI is to focus on countries with high CPI rates. A country with a high CPI rate is more likely to have a central bank that raises interest rates to control inflation, which strengthens money. Therefore, traders can buy the currency of a country with a high CPI rate against the currency of a country with a low CPI rate. For example, traders can buy the USD/JPY currency pair if the US CPI is higher than Japan. As the US central bank raises interest rates to control inflation, the dollar's value will rise against the yen.

2. Trading currency pairs during CPI releases:

Another way to trade CPI is to trade currency pairs of countries during the release of CPI data. CPI data is usually released monthly and can cause significant fluctuations in the market. Traders can enter the market before or after the release of CPI data. Traders can buy the currency pair in hopes that the central bank will raise interest rates to control inflation if the CPI data is higher than expected, which will increase the currency's value. Traders can sell the currency pair as the central bank may cut interest rates to stimulate economic growth if the CPI data comes in lower than expected.

It is important to note that trading CPI data can be risky as the market can fluctuate wildly during the data release. Therefore, traders should use a stop-loss order to limit their losses if the market moves against their analysis.

Summary

CPI is an important economic indicator that forex traders use to make conscious decisions about trading currency pairs. By tracking the average price changes of goods and services over time, traders can gain insight into the level of inflation in an economy. This can help traders make decisions about buying and selling currencies based on the expected impact of interest rates on exchange rates. While the CPI is not the only factor affecting the forex market, it is an important tool for traders who want to stay informed of the latest economic data releases.