The CPI (Consumer Price Index) is used to measure the level of inflation (and potentially deflation) in an economy. Although not used everywhere, it is a standard gauge that measures general price increases for countries. It is used by governments, central banks and market participants and is considered to be a benchmark to compare inflation in economies around the world.
The CPI is measured by calculating a representative “basket” of goods and services. The aggregate movement in the prices of the basket is used to calculate the broad changes in prices for the economy.
The CPI is tier-one economic data and has the potential to significantly move domestic bonds, currencies and indices. The US CPI will also have a big impact on commodities too.
The CPI tracks the changes in prices of a “basket” of goods and services. Amongst others it includes:
- Food – the cost to buy food in the shops
- Energy –the cost of heating your home
- Transport – the cost of putting fuel in the car and public transport prices
- Housing & Household goods – the cost of rent, along with furniture and household appliances
- Apparel – changes to the cost of clothing and footwear
- Recreation – the cost of entertainment such as gym memberships and eating out
- Health & Education – The costs for medical treatment and education services
According to the US Bureau of Labor Statistics, the CPI collects the pricing data of around 94,000 goods and services every month. “Core” CPI strips out some of the more volatile aspects such as food and energy costs.
Why is it important?
The CPI is a key gauge of inflation. It is used by retailers to adjust their prices. It is used in the negotiation of salaries. It is used by governments to determine the cost of living for the calculation of social security and benefits.
If higher inflation expectations become embedded they can generate an upward spiral in general price levels. When inflation is high, the value of money declines at a faster rate.
Broad Impact
Higher inflation increases the potential for tighter monetary policy (central banks raising interest rates). If inflation is rising above the central bank’s target level, the bank will increase interest rates to “choke off” the price rises.
Higher interest rates tend to increase bond yields and increase demand for the domestic currency.
Trading the data
As ever, it is all about the expectation. Higher than forecast CPI will be positive for the domestic currency. However, equities will tend to react negatively. The potential for higher interest rates is negative for corporates and consumer spending as it increases the cost of borrowing.
