Part III. Fundamental Analysis / Chapter 8. Key Inflation Indicators

In the previous chapter, we briefly discussed the topic of inflation, explored its various forms, and its impact on the economy. However, inflation, like other economic indicators, needs to be quantified before it can be applied to forecasting currency exchange rates in the Forex market. In this chapter, we will focus on the indicators used to measure inflation.

The key indicators used to assess inflation are:

• Consumer Price (consumer price index, CPI);
• Producer Price Index (PPI) (producer price index, PPI).

Consumer Price Index (CPI): The CPI provides a perspective on inflation from the consumer side. It measures the average change in prices of a fixed basket of goods and services that are commonly consumed. This basket includes items such as food, clothing, fuel, medical services, transportation expenses, and more. CPI also incorporates imported goods, services, and taxes.

Producer Price Index (PPI): The PPI focuses on inflation from the producer side. It measures the average change over time in the selling prices received by domestic producers for their output. It reflects price movements at various stages of production, such as raw materials, intermediate goods, and finished products.

The estimation of the consumer basket is conducted on a monthly basis. In the United States, this task is carried out by the Bureau of Labor Statistics. Determining the composition of the consumer basket is a complex task as it depends on the specific consumption patterns of the population in each country. In the U.S., the basic consumer basket is calculated based on data from 19,000 retail establishments and 57,000 households. Approximately 44% of the basket consists of goods, while 56% comprises services. Statistics are collected from 85 cities and averaged using special coefficients. The composition of the basket is reevaluated every 10 years based on studies of household expenditure patterns.

The CPI index is published on the 13th day of each month at 16:30 Moscow time. It reflects the value of the index for the previous month. To calculate this index, the price of the current period's consumer basket is divided by the price of the consumer basket from the previous period. The resulting value is then subtracted by one and expressed as a percentage. A positive CPI value indicates an increase in the price of the consumer basket. On the other hand, a negative value, although rare in practice, would indicate a decrease in the price of the consumer basket.

The prices of food and energy sources are subject to the greatest fluctuations in the composition of the consumer basket. Therefore, in addition to the CPI index, the Core CPI index is also published. The Core CPI excludes food and energy components from the basket to provide a measure of inflation that focuses on other goods and services.

It is believed that the CPI index slightly overestimates the real inflation rate in a country because it is calculated based on a fixed basket and does not account for the introduction of new goods and services. It also ignores seasonal discounts and relies solely on the stated prices by sellers. However, despite these limitations, the CPI index is widely used by financial analysts to forecast currency movements in the Forex market.

In a normally developing economy, an increase in the CPI index indicates inflationary pressures, which may lead to a response from the central bank. Typically, central banks raise interest rates in order to counter inflation. An increase in the interest rate attracts foreign capital to the country, thereby increasing demand for its national currency.

Under normal economic conditions, there is a direct correlation between the CPI index and the exchange rate of the national currency – an increase in the CPI value is generally accompanied by an increase in the currency's exchange rate. This relationship is particularly noticeable when the published CPI value significantly deviates from expectations, triggering an immediate market reaction. However, in an unstable economy, rapid inflation only leads to a decline in foreign investors' confidence in the national economy, capital outflows, and a subsequent depreciation of the national currency.

Стоит заметить, что показатель PPI не учитывает сервисные услуги, строительство и импорт. Но несмотря на то, что цены на импортные товары напрямую в показателе PPI не учитываются, они оказывают косвенное влияние через цены на комплектующие и сырье. Главное отличие PPI от CPI, таким образом, в том, что данный показатель учитывает только товары на оптовом уровне их реализации, но не услуги.

The Producer Price Index (PPI) shares similar characteristics with CPI. This index reflects the average price changes for producers at all stages of production. The PPI index consists of two components. On one hand, it takes into account prices for intermediate goods and components, also known as input prices in the production process. On the other hand, it includes prices for finished goods, known as output prices. The basket of producer prices is calculated based on 22,000 companies and 3,000 commodities. The PPI index covers sectors such as energy, agriculture, textiles, mining, forestry, and military industries.

It's worth noting that the PPI index does not include services, construction, and imports. However, although prices of imported goods are not directly included in the PPI index, they indirectly influence it through their impact on component and raw material prices. The main difference between PPI and CPI is that the PPI index only considers goods at the wholesale level of their sales, excluding services.

The PPI index is calculated using the same principle as the CPI. The total value of the base basket in the current period is divided by the value of the previous period, and then one is subtracted from the resulting value. The result is expressed as a percentage, and the value can be either positive or negative. Unlike the CPI index, the PPI index has periods of noticeable decline when the published values are negative. The PPI index and the exchange rate of the national currency have a direct correlation – an increase in the PPI index generally leads to an increase in the exchange rate of the national currency, and vice versa.

The rise in PPI leads to cost-push inflation, which, according to financial analysts, has a more profound impact on the economy than demand-pull inflation and is more detrimental to it. The PPI index is usually leading compared to the CPI, as consumer prices change with a delay compared to wholesale prices of goods. The PPI index is published on the 11th day of each month at 16:30 Moscow time. The publication reflects the value of the index for the previous month. Similarly to the consumer price index, the industrial price index is considered more reliable if it excludes the food and energy industries. The corresponding indicator is called CorePPI and is published together with the main index.

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