Forex Education: Understanding Consumer Inflation Reports

Forex Education:  Understanding Consumer Inflation Reports

For traders looking to implement fundamental trading strategies, it is important to have an understanding of what each report means so that we can have some of idea of how markets will react once the latest results are released.  One of the most commonly watched economic releases is the Consumer Price Index (CPI), which is a broad measure of consumer inflation.

Inflation is a very common measure of economic performance — and this information can give traders some key indications of how the currency will perform once the data is released.  First, it should be understood that inflation is a measurement of price increases over a certain period of time.   Inflation data is also measured on a monthly and yearly basis (similar to Retail Sales figures) and all of those same rules apply to the way that markets are expected to be have once these releases are made public.

There are some key differences, though, that should be understood.  To see these differences, we first look at prices that are paid for common goods at the consumer level and then at the producer level.  Prices at the consumer level can be seen at the final level of the sales process.  When you buy something in the supermarket or in the corner store, you are paying prices at the consumer level.  In contrast to this, markets also measure prices at the producer level, which essentially relates to the prices that producer companies pay for their raw materials.

Why Inflation is Important for Forex Traders      

Investors separate this information so that there can be an in depth analysis of different sections of the economy.  Generally speaking, price inflation at the consumer level gets more attention because this is seen as affecting a larger number of people.  Both of these pieces of information relate to each other, however, as rises in producer prices are often thought to create prices gains at the consumer level at a later date.

Why do price increases matter to investors?  Why would this affect price activity in the forex pairs that are associated with the currency of the country?  “Most directly, price inflation is seen as being one of the major drivers in whether or not a country will choose to raise or lower interest rates,” said Ann Gorenkova, currency analyst at NordFX Company.  “In general, central banks will choose to raise interest rates if consumer price inflation is seen rising too drastically.”

Conversely, central banks are often placed in a position where they must lower interest rate levels if consumer prices are seen falling too drastically.  This can, ultimately, be a major driver of what happens in currency markets as the level of interest rates is one of the key factors that investors use to determine appropriate exchange rates relative to other commonly traded currencies.  For these reasons, it is important to remain aware of these data results before committing to any new position approach.