How to Interpret Inflation Data?

Analyzing AUD/USD quotes

Analyzing AUD/USD quotes

The Consumer Price Index, better known as CPI, is an important economic indicator regularly published by major economies to provide timely information on current inflation. It is a very important indicator that significantly affects central banks' monetary policy. In turn, central bank policy determines the course of the economy to tighten or soften, which is reflected in national currencies and the dynamics of stock markets. So, how to correctly interpret the Consumer Price Index data?

The publication and revision of CPI figures can cause fluctuations in the value of currencies against other currencies, potentially favorable volatility that can benefit experienced traders. When using CPI data to influence forex trading decisions, traders should consider not only actual values but also market expectations of inflation and what might happen to the currency if those expectations are met or not met. Therefore, it is not so easy to predict the movement of a currency pair when news is published. But let's try. Let's consider the real situation with an example to make it more clear.

On April 27 at 04:30 (GMT+3), the Australian Bureau of Statistics released quarterly data on inflation in the country. CPI release dates are usually published monthly but quarterly in some countries, such as New Zealand and Australia. The inflation rate increased from 1.3% to 2.1%, with consumer prices rising 0.8% in 3 months. At the same time, analysts expected growth of 0.4% to 1.7%. So the forecast turned out to be worse than expected. When the news came out, AUD/USD quotes jumped but then continued their bearish trend. Why did this happen? It should be noted that the rate of the national currency in the medium and long term depends on central banks' monetary policy. Investors tend to embed future scenarios into the price now. Therefore, in the news release, the price usually moves in one direction, and after it – in the opposite.

  • Inflation growth above analysts' expectations means that investors will bet on a more aggressive monetary policy tightening by the central bank. Tightening monetary policy strengthens the exchange rate of the national currency. For this reason, a sharp rise in the inflation rate may raise the national currency quotes, which happened with the AUD/USD currency pair at the time of the actual news publication.
  • Inflation growth at the level of expectations, as a rule, affects the exchange rate slightly because there were no "surprises."
  • Inflation growth below expectations may have a negative impact on the national currency rate as inflation is not growing fast, and the central bank will have no reason to tighten monetary policy.
But why did AUD/USD continue to fall for some time after the news release?
The exchange rate of the currency pair is formed by the monetary policy of 2 countries. And while in Australia, the annual inflation rate reached 5.1%, in the USA, the annual inflation rate is at a record level of 8.5%, and the US Federal Reserve has already announced that it will aggressively raise interest rates in the next three meetings. That is why the dollar index is strengthening much more than the Australian dollar, leading to a decline in the AUD/USD in the medium term. In the same way, we can analyze the USD/JPY quotes, where the opposite monetary policies of the United States and Japan central banks led to a strong uptrend in the USD/JPY currency pair.

by JustMarkets, 2022.05.17

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