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Forex and the CPI: How CPI Data Impacts Currency Prices

by Elena Martin   ·  September 22, 2022  

Forex and the CPI: How CPI Data Impacts Currency Prices

by Elena Martin   ·  September 22, 2022  
We’ll look at what traders need to know about the Consumer Price Index to make wise selections as we examine CPI and FX trading in this post. We’ll discuss the basic idea behind CPI, the dates on which it is released, how to understand CPI, and what factors to consider while trading forex using CPI data.
WHO ARE FOREX TRADERS, AND WHY DO THEY CARE ABOUT CPI?

The Consumer Price Index, often known by its abbreviation CPI, is an essential economic indicator regularly issued by major countries to provide a convenient window into current growth and inflation levels.

As measured by the CPI, inflation focuses on the growth in prices of goods and services in an economy and the impact on buying power, which may affect a country’s monetary policy.

The consumer price index, or CPI, is derived by averaging price increases for each item in a preset basket of consumer products, such as food, energy, and services like medical care.

DATES OF CPI RELEASES

The CPI is typically released monthly, while some nations, such as Australia and New Zealand, provide it quarterly. Some countries, like Germany, also provide annual results. Since 1913, the US Bureau of Labor Statistics has published a monthly CPI report.

The leading economies and details about their CPI announcements are included in the table below.

Forex

Due to its influence on monetary policy and the subsequent effect on interest rates, which directly affect currency strength, it is a helpful indicator for forex traders. Below, it will be discussed how useful it is for forex traders to understand how to read CPI.

WHY FOREX TRADER SHOULD PAY ATTENTION TO CPI DATA

Since the CPI is a reliable indicator of inflation and central banks‘ monetary policy, forex traders must understand this data.

How does the CPI impact the economy, then? To slow the economy and curb inflationary tendencies, governments often set higher benchmark interest rates when inflation is more elevated. In consequence, a nation’s currency is more likely to strengthen the higher its interest rate. On the other hand, countries with lower interest rates often have weaker currencies.

A currency’s value versus other currencies may fluctuate due to the publication and adjustment of CPI numbers, indicating positive volatility from which smart traders can profit.

Additionally, CPI data is often seen as a helpful indicator of how healthy governments are responding to the state of their domestic economies, which forex traders may consider when determining the probability of currency moves.

The Producer Price Index and other indices, such as the CPI, may provide forex traders with a fuller view of inflationary forces.

WHEN TRADING FOREX AGAINST CPI DATA, WHAT TO CONSIDER

Traders should consider market expectations for inflation and what will happen to the currency if these expectations are realized or missed when utilizing CPI data to impact forex trading choices.

Similar to any significant release, it can be wise to refrain from holding an open position just before. Since forex spreads may expand dramatically just before and after the report, traders may want to hold off on searching for potential trades until a few minutes following the publication.

The US monthly inflation rates are shown in the chart below. Inflation forecasts for the most recent month are 1.6% higher than those for last year’s period. This news event can affect the market if the CPI report is higher or lower than anticipated.

Forex
Chart to show US inflation levels in 2018/19. Source: TradingEconomics.com. US Bureau of Labor Statistics

Monitoring the US Dollar Index is one technique to understand the implications of CPI data; a sample chart for 2018–19 is shown below. It is plausible to assume that if CPI is issued contrary to expectations, this might act as the impetus for the Index to reach new highs or overcome resistance.

Since the Index consists of the EUR/USD, USD/JPY, and GBP/USD pairs, we can fully determine the result of the event by monitoring the US Dollar.

Chart to show movement in the US Dollar Index. Source: TradingView.com

As shown in the example above, the US Dollar Index increased with rising inflation during the first half of 2018. However, US interest rate rises were put off due to US inflation drifting lower in the following months and a missed 2% objective. The dollar struggled and fell versus a basket of other currencies.

Not every actual news item has the desired price reaction.

Traders should check to see whether the market price is moving through or reversing off any regions of technical relevance once the CPI data has been issued and digested. Trading choices will be improved due to traders’ increased understanding of the short-term strength of the move and the strength of technical support or resistance levels.