What is CPI? (Key points/cheat sheet)

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  • Here are the key points from our video ‘What is CPI? (Consumer Price Index- Inflation Data) [Macroeconomics/ Economic Data Releases].’ The video is available on our YouTube channel and at the bottom of this article.
  • CPI, or Consumer Price Index, is a monthly release which measures the prices consumers paid for goods and services in the economy and how these have changed compared to previous months.
  • The best way to understand the way CPI is measured, is to think of it as a shopping basket full of day to day items or goods. This will include a range of items that are included in regular household spending, with some exclusions such as housing costs, which are generally not included but may be included in other specific alternative ways of measuring inflation.
  • The specific items included in the index will vary depending on the economy, and some releases may even be split into different categories, such as the US release which is split into CPI-U for all Urban consumers which represents 89% of the population and CPI-W which is for Urban wage earners and clerical workers, which represents 28% of the population.
  • The basket of goods doesn’t include every item we all buy, as that wouldn’t really be possible to collect regularly, so instead it simply represents a sample of what we call “representative items”. For example, in the UK CPI release, there are 700 separate items and over 100,000 prices are collected for these.
  • The index is then weighted to give more importance to certain items over others, for example a rise in the price of petrol is more important than certain food items which can be substituted.
  • Some people incorrectly assume CPI is for essential items or is a gauge of cost of living. This is not necessarily true. For example, the UK release includes the price of cigarettes, which is not an essential item for most people. It also isn’t intended to be showing a cost of living since people’s day to day items are different. Instead, it should be used as a useful estimate of how inflation is affecting most people’s spending needs.
  • When we looked at GDP in a previous video, we understood that when more money enters the inner flow, this means more money is going to companies, which in turn means they can employ more workers and raise salaries as well. Which ties in with the boom and bust cycle we discussed in our video on PMI and how PMI helps us to anticipate when this is likely to be happening.
  • When we looked at NFP and employment data, we saw that not only are jobs number reported, but also the wages increase or decrease. So we can start to see how much additional consumer spending may be likely to happen in an economy. Going back to our understanding of GDP and Boom and Bust cycles, we know an increase in spending is likely to lead to inflation, as prices of goods increase through aggregate supply and demand.
  • When inflation starts to rise, this can also lead central banks to take action, as they aim to keep inflation under control and within certain boundaries. For example, the Federal Reserve in the US at the moment has an inflation target of 2%. A central bank will usually increase interest rates to reduce inflation in an economy. This is meant to discourage excessive borrowing, since the cost of borrowing is higher and encourages more saving. Both of which result in less money circulating in an economy, leading to less spending and a reduction in inflation.
  • This means central banks really follow CPI data closely. In particular, in the US, the Federal reserve monitor CPI, PPI, and the unemployment data, to help make their decisions in a market. So because of this, inflation data can really move a market heavily, especially when it surprises against expectations.
  • A rise in inflation will likely lead to a bullish move in that currency, based on the factors we’ve discussed and considering the purchasing power of that currency. However, this will also depend on other contextual factors, such as expectations of future action, what has taken place in the recent past and the general economic conditions of the time.

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