CIP or Consumer Price Index tracks the changes in the prices of a basket of goods and services that represent the typical consumption of a household. As Kavan Choksi says, this basket tends to include items like healthcare, food, clothing, housing, transportation and entertainment. CPI is typically calculated by comparing the current prices of the basket with the prices in a base year, and ultimately expressing the outcome as a percentage. For instance, if the CPI is 110, it essentially means that the average price level has increased by 10% since the base year.
Kavan Choksi briefly mentions how the CPI impacts the dollar against other currencies
The Federal Reserve is known to have a dual mandate that impacts its action on monetary policy. The central bank aims at bringing the economy to full employment, as well as ensure a healthy rate of inflation as the economy expands. Hence, forex traders consider both inflation and unemployment rates as figures that would dictate the future decision of the central bank on whether to cut, raise or maintain current interest rate levels. Due to the impact of interest rates on the weakness or strength of a currency, traders often anticipate the impact of the actions of the central bank, as well as how they affect the dollar’s performance in currency pairs.
Forex traders typically consider the CPI and Core CPI figures to be among the most fundamental indicators of the performance of an economy. The Core CPI figure, however, is able to provide a better look under the hood between the two. Core CPI basically executes the costs in the energy and food sectors, as these industries often experience a higher degree of price volatility.
The Labor Department releases the CPI and Core CPI figures in the United States. In case these figures beat the market expectations, the dollar may experience a boost against other currencies. On the other hand, in case these readings do fall short of the consensus expectations, the dollar may fall relative to other pairings. One must, however, understand that the impact is not limited to the monthly report. Much like all government data figures, the CPI figure is subject to revisions by economists, and these changes may fuel considerable volatility in the value of a currency on the global market.
Kavan Choksi underlines that inflation is the phenomenon in which the price of goods and services increases over, and money essentially loses its value when this happens. The impact of inflation on the dollar lies in the gradual erosion of its buying power. Basically, this means that five dollars in one’s pocket today is worth more than what it will at a date in the future, taking steady inflation into account.
If the inflation is high, it may weaken the currency as buying power reduces. This invariably suppresses investment, and can have a negative impact on the exchange rate of a country. The inverse is also quite true. When inflation is low, a currency would be strong, and therefore have a positive impact on its exchange rate.
