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How Does the CPI Affect a Currency?

May 10, 2021
Theo Ashley-Hacker

What is the CPI?

The CPI or Consumer Price Index is a figure released monthly that measures the average change in a basket of goods in an economy, its used to measure inflation and is a key figure used by central banks around the world that influences monetary policy decisions such as interest rates.

What can we Expect on Wednesday?

Economists forecast the figure to at 0.2%. However like last month, its likely to be higher than this as more people get vaccinated and the economy continues to open up. Hourly earnings coming out last week higher than expected is also important as employees are often paid more when the companies are charging more for their products. When people are being paid more they also have more spend more increases inflation.

What affect does it have on the currency?

Its a commonly misunderstood that higher than expected CPI devalues a currency, and this would make sense, right? As inflation occurs and as prices rise, they become less competitive internationally and the currency becomes less sought after. There is however another side to this.

Investors often perceive higher than expected CPI figures to be bullish. This is as central banks set an inflation target which they aim to keep low and steady. If figures come out considerably higher than their target, they may look to adjust interest rates. Higher interest rates would mean people are less likely to spend money as borrowing becomes more expensive and saving more lucrative. This aims to decrease spending and inflation accordingly. Higher Interest rates increase demand for a currency as people look to move their money where they can get the highest returns before likeminded people drive the price up in anticipation of higher interest rates.

Likewise, lower than expected CPI figures can be bearish as central banks may look to lower interest rates to stimulate consumer spending and demand in the economy.

Conclusion

The Consumer Price Index is one of the most anticipated economical indicators as it gives a good all round idea of the state of the economy, it has the the potential to benefit a currency but only if investors believe that the figures are off enough that central banks may consider policy changes as a result, but not off by so much that it can affect confidence in the economy..

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