Economic Indicators: Consumer Price Index (CPI)

The Consumer Price Index (CPI) is the benchmark inflation guide for the U.S. economy. It uses a "basket of goods" approach that aims to compare a consistent base of products from year to year, focusing on products that are bought and used by consumers on a daily basis. The price of your milk, eggs, toothpaste and a hair cut are all captured in the CPI.

The CPI is compiled by the Bureau of Labor Statistics each month around the middle of the month. The BLS site describes the CPI as follow, “The Consumer Price Indexes (CPI) program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.”

How it works

The CPI measures the retail price changes of about 80,000 goods and services purchased by consumers, called a market basket. The market basket covers over 180 categories falling into eight major groupings:

•  Food and beverage
•  Housing
•  Apparel
•  Transportation
•  Medical care
• Recreation
• Education and communication
• Other

The market basket is updated every few years by the BLS to remove goods and services that might have become obsolete or irrelevant.

There is a base period for the CPI: the current base period is the 36 month period encompassing the years 1982-1984. This base period is equal to “100” on the index. Subsequent measurements are expressed as some multiple of this base period, for example a 20% increase would be expressed as “120.”

Why the CPI is important?

Many experts consider CPI as the best gauge of inflation available to investors and others. Inflation has an impact on interest rates and many business and investing decisions. An accurate measure of inflation is key to decision makers in formulating their plans.

The CPI is probably the single most important economic indicator available, if for no other reason than because it's very final. Many other indicators derive most of their value from the predictive ability of the CPI, so when this release arrives, many questions will be answered in the markets. This report will often move both equity and fixed-income markets, both the day of the release and on an ongoing basis. It may even set a new course in the markets for upcoming months. Analysts will be more sure of their convictions about what the Fed will do at the next Federal Open Market Committee meeting after digesting the Consumer Price Index.

Strengths:

• Gives the most insight into future Fed rate moves
• Highly watched and analyzed in the media
• Good regional and industry breakdowns for investor research

Weaknesses:

• Month to month volatility
• Fixed CPI has certain biases (new product, substitution), which can distort results