General Definition
The Consumer Price Index or CPI is a measure that estimates the average price of consumer goods and services. The CPI measures the price change for a set of market goods and services from a fixed term until the next within the same area, be it a city, region or country. This is a monthly figure, which always refers to the previous month in which the Bureau of Labor Statistics issued the report.
The Bureau of Labor Statistics of the U.S. measures two kinds of CPI statistics:
- CPI for urban wage earners and administrative staff (CPI-W).
- CPI for All Urban Consumers (C-CPI-U).
Of the two types of CPI, it is considered that the latter is the most representative of the general population, accounting for 87% of the population of the country.
Relevance of the index
The percentage change in the CPI price is used as a measure of inflation. The CPI can be used for indexing (effect of adjusting for inflation) the real value of wages and pensions, in such way that they meet the cost of living. In most countries, the CPI is, along with the Census of Population and Gross Domestic Product figure, one of the national economic data in United States more closely watched by markets and businesses.
Effects of the indicator in the market
The Consumer Price Index is one of the statistical data taken into account to identify periods of inflation or deflation. This is because large increases in the index for a short period of time usually indicate a stage of inflation, and large falls in the index for a short period of time usually indicates a period of deflation.
When the index is rising, the investors may fear that the inflation will rise significantly which may lead to an increase in the interest rates in the country, so the stock markets could account for this possible unfavorable scenario with declines in share prices on stock markets. This is because increases in interest rates ends up affecting the consumer demand by reducing consumption as the price of consumer finance begins to rise. Also, increased interest rates affects the cost of corporate financing, thereby reducing their profits.
When the CPI is growing and there is an inflation scenario, the predictable result is a depreciation of bond prices in the market and increased profitability of the new bonds issued, and that interest rates will increase as inflation is manifested more strongly. Therefore, it is a logical conclusion that and increase in the CPI can cause both a fall in equity markets and as bond markets, as investors trading in both markets fear the likely consequences of the increase in the CPI through the rising in the interest rates .
Due to the impact of inflation on interest rates, which affects the rates of return on domestic public and private debt, the price evolution of the country’s currency moves largely by CPI data. Presumably, an expected increase in interest rates, tends to cause a strengthening of the national currency as there will be more investors attracted by high interest rates of the country’s debt. However, the price of the currency also takes into account the strength and solvency of the national economy. Therefore, take only the CPI data to predict the evolution of a national currency can be clearly a mistake.
