Consumer Price Index

What it Measures:

The Consumer Price Index or CPI is sometimes also called “headline inflation” and consists of a weighted average that measures the change in prices of a fixed basket of consumer goods and services that are weighted in order of importance. Goods include such items as: food, housing, transportation, medical care, recreation, education and apparel.

Core CPI is the weighted average of price changes for goods and services, with food and energy prices excluded. Food and energy products account for a quarter of the CPI which can give an unreliable picture of the overall inflationary trend because of the volatility in these commodities.

As a result, the Federal Reserve and top economists usually prefer using Core CPI to gauge actual levels of inflation in the economy to adjust interest rates accordingly. Currency traders also use Core CPI since it is a more precise and less volatile gauge of inflation.

What effect it has:

If the U.S. Consumer Price Index or CPI or Core CPI number comes out higher-than-expected, that usually appreciates the U.S. Dollar. On the other hand, a lower-than-expected number will tend to prompt the Dollar’s decline.

CPI, and in particular Core CPI, is one of the most widely-watched of all fundamental indicators, and its revisions can also result in significant market activity. CPI movements can influence equity prices and currency exchange rates due to its implications for interest-rate policy set by the Federal Reserve.

How often it is released:

The Bureau of Labor Statistics releases the Consumer Price Index monthly, typically between the 13th and 19th of the month. The monthly report is for the preceding month.

Why it is important:

Changes in the prices of consumer goods are perhaps the most direct measure of inflationary forces in the economy. A rising CPI will indicate that the economy is in an inflationary cycle and the value of money is declining. In order to contain inflation, the Federal Reserve may respond by raising interest rates and this in turn will affect all other areas of the U.S. economy. A falling CPI, on the other hand, indicates a deflationary environment which may prompt the Fed to reduce rates.

In general, the level of inflation in the economy affects all consumers. Also, the Federal Reserve relies partly on this key CPI data to formulate monetary policy since the central bank has an inflation containment mandate and so will need to raise rates to contain inflation or lower interest rates in the face of deflation. Each of these adjustments will in turn affect prices, economic activity and the valuation of the country’s currency.