Welcome to the first episode of our Fundamental Fun with Orbex, where we’ll be looking at UK CPI!
In today’s look at fundamental analysis, we’ll be talking about UK CPI data, and some things to keep in mind when trading around this data release.
CPI stands for Consumer Price Index, which is made from averaging the change in cost for various consumer goods and service, so it’s given in percentages. It’s one of the ways of measuring inflation, with a positive number indicating inflation and a negative number deflation. It’s released once a month by the Bank of England, or BoE as it’s often known.
Why the CPI release is important is because it’s one of the key data used by the BoE in deciding whether or not to take measures to stabilize the currency. Remember, it’s the responsibility of the BoE to keep the value of the pound stable within an inflation target that they’ve set at 1 to 3%.
Consequently, in general, if CPI data comes out above expectations, the market is likely to interpret this as supporting the possibility the BoE will be closer to taking action to curb inflation. This means trading pairs could be expected to go up. On the flip side, if the data misses expectations, this is likely to be seen as potential for the BoE to be inclined towards actions that would support inflation. This means that sterling pairs could be expected to drop.
You might be thinking, hang on… higher inflation means that the currency is worth less. Why then would the value of the currency go up in relation to others if there is more inflation than expected? Well, that’s because the main tool the central bank has to control inflation is to raise interest rates, and that is seen as increasing demand for that particular currency and therefore it’s value relative to others.
Along with the CPI data, the Bank of England also releases RPI, which is the Retail Price Index. While it’s calculated using a different method, it still tries to measure the same thing: the level of inflation. RPI data is considered as not as important, and often it just reinforces the market’s view of the CPI data.
Now, it’s quite possible, and it does happen sometimes, that RPI and CPI data will contradict each other; or one will be in line while the other doesn’t match expectations. This leads to a bit of market volatility around this release, as traders price in which of the readings to uses as a guide.
Typically you can see swings of up to between 30 and 40 pips during the first minutes after the release. That might sound interesting if you like to trade on volatility; but if you are shy of erratic market moves, you might want to wait five to ten minutes for the market to process the data.
