Consumer & Producer Price Indices
What are price indices?
Price indices are economic indicators that measure the average changes in the prices of goods and services over time.
These usually have a base index set to 100, and then each subsequent period is represented as a percentage change from this base index.
In calculating this index, a basket of goods is decided upon, and prices are collected monthly for each item.
Consumer Price Index
The Consumer Price Index (CPI) measures the average price of a basket of household goods and services. The CPI is an essential economic indicator that helps to measure inflation and purchasing power. The scope and calculation methods of the CPI can differ across major economies depending on the data sources, the weighting system, and the basket of goods and services included in the calculation.
For instance, the Bureau of Labor Statistics (BLS) calculates the US CPI, which tracks changes in the cost of a selection of goods and services that urban consumers purchase. The basket of goods and services includes food, housing, transportation, medical care, apparel, recreation, education, and communication. The BLS uses a base period of 1982-1984 and adjusts the basket of goods and services every two years based on the expenditure patterns of households.
Similarly, Eurostat determines the Euro Area CPI, which tracks changes in the cost of various goods and services that Euro area households use, such as food, alcohol, tobacco, clothing, housing, energy, transport, communications, and recreation. Eurostat uses a base period of 2015 and updates the basket of goods and services every year based on the expenditure patterns of households.
The Ministry of Internal Affairs and Communications calculates the Japanese CPI, which tracks changes in the cost of a basket of goods and services that urban households use. The basket of goods and services includes similar household items to other countries. But, of course, the weightings and specific goods differ to account for regional differences, tastes, preferences, etc.
Producer Price Index
The Producer Price Index (PPI) measures the average change over time in the selling prices received by domestic producers for their output. The PPI tracks the price changes for goods and services at the producer or wholesale level before they reach the final consumer. The PPI is an important economic indicator that provides insight into the direction of inflation in the economy.
The PPI tracks price changes for a wide range of goods and services, such as raw materials, goods in the middle of the production process, and finished goods. In the US, it is calculated monthly by the Bureau of Labor Statistics (BLS) and similar agencies in other countries.
Like the Consumer Price Index (CPI), the PPI is calculated using a weighted index formula. The weights are based on the value of shipments of products in the base year, which is usually set at 100. The PPI component weights are fixed at the base year and do not change over time.
The PPI is often used as a leading indicator of inflation because changes in the prices of goods at the producer level can be passed on to consumers through higher prices for final goods and services. In addition, the PPI can also provide insights into the economy's direction, as changes in producer prices can indicate changes in demand or supply conditions.
Overall, the PPI is an essential tool for policymakers, businesses, and investors to monitor price trends and make informed decisions about economic activity.
How CPI figures can impact the Forex market
The CPI can significantly impact the forex market. Higher inflation can cause a central bank to increase interest rates to curb inflation. Higher interest rates make a country's currency more attractive to investors, increasing demand for that currency and strengthening its value in the forex market.
Therefore, forex traders often closely monitor CPI releases and use them to predict how a central bank may adjust interest rates. For example, suppose a trader anticipates a central bank will raise interest rates due to rising inflation. In that case, they may buy that country's currency in anticipation of its value increasing. Conversely, if a trader expects interest rates to be lowered due to falling inflation, they may sell that country's currency in anticipation of its value decreasing.
Market expectations are key trading economic figures, and forex values can move wildly on CPI and PPI announcements. Computer traders can dominate the market in the first minute after the announcement, making it difficult to trade. It is usually best to wait until the market quietens to make a trading decision.