There are a number of inflation indicators forex traders can track to gauge the level of price stability within an economy
Consumer price index
A consumer price index (CPI) is a measure of the average price of consumer goods and services purchased by households within an economy. It measures the average change in prices paid for a constant basket of goods and services from one period to the next within the same area. It is compiled from a sample of prices for food, shelter, fuel, clothing, transportation and medical services.
The percentage change in the CPI is the main measure for estimating inflation, or price growth, within an economy and changes in the cost of living. Rapid increases in the value of the CPI indicate inflation; rapid decreases can suggest the onset of deflation – a decrease in the price of goods and services leading to low or no economic growth. Economists and other market analysts tend to focus on the CPI-U figure in the United States. The CPI-U figure, or the core inflation rate, excludes food and energy components from the measurement, as these tend to be the most volatile and seasonal prices.
The US Federal Reserve, like all central banks, closely monitors the CPI as its main indicator of inflation within the economy. Sudden or unpredicted changes to the CPI lead to sharp increases in currency market volatility as traders react to changes in the CPI number in anticipation of moves by the central bank to keep inflation under control.
Producer price index
The producer price index (PPI) is a collection of indices that measure price changes by domestic producers, and how the producers’ cost of materials can be passed on to consumers in the form of higher prices for their finished goods. The PPI measures price changes from the business side as opposed to the CPI, which measures price changes from the consumer side – what businesses are charging rather than what people are paying for products. The PPI records changes in prices in percentage terms over the previous recording period for a wide range of industries in the US economy, including manufacturing, mining, agriculture, forestry, fishing and energy production. It is a broad-based indicator that reflects changes in production costs across virtually the whole US economy, providing a valuable insight into any inflationary pressures that may be starting to build. If producers are paying more for their inputs, these costs will be passed onto consumers, which in turn affects the CPI.
Commodity Research Bureau Futures Index
The Commodity Research Bureau Futures Index (CRB Index) measures changes in the prices of 17 commodities actively traded on US futures exchanges; these commodities are raw materials or products that are associated with the beginning stages of production. Changes in the prices of these materials are among the first to react to changing economic conditions. It is an early indicator of changes in the business climate and inflation. The CRB Index is also an actively traded futures contract, so tracking changes in the value of the index is simply a matter of monitoring changes in the price of the CRB futures contract. The commodities included in the CRB Index and their sub-group weightings within the index are shown in the table.
The CRB Index makes it relatively easy to watch for changes in commodity prices and inflationary trends.
This edited extract was from ‘Forex Made Simple: Simple, Easy to Understand Strategies Anyone Can Use for Success!’ by Kel Butcher. The book is available through Wrightbooks. RRP $27.95.