Your Guide to Trading This Week’s CPI Reports

Are you ready to get bombarded by CPI figures coming in from China, the U.K., the U.S., and euro zone? Better mark those calendars for this week’s inflation reports!

Wait a minute. Why are we fussing about CPI and inflation in the first place?

Excellent question! You see, CPI or consumer price index is the most widely known measure of inflation. Keeping track of inflation is important for us traders because central banks usually base their monetary policy decisions on the changes in price levels. Central banks like to keep price levels stable so they use their monetary policy tools, such as interest rates and money supply, in order to keep inflation in check.

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If you’ve been a loyal reader of Pip Diddy’s forex fundamentals, you’d know that commodity prices have been on a tear in the past few months. Because of that, traders are on their toes, anticipating that central banks would soon tighten their monetary policy.

This week’s CPI reports will most probably give way to interest rate speculations, which is one of the major factors driving price action. Here’s a sneak preview of the upcoming inflation releases for those who are planning to trade the news this week.

China (Tuesday, 2:00 am GMT)

China has been infamous for pumping out one impressive figure after another, so it shouldn’t be surprising if their annual CPI figure for May posts another huge gain. Heck, their annual inflation rate was able to skyrocket from 4.6% to 5.3% in a span of six months!

I took a short trip down memory lane to see how the Chinese central bank reacted to this jump in inflation. And do you know what I realized? The PBoC had already implemented SIX rate hikes during the first four months of this year! Two of these hikes involved their actual benchmark rate while the other four increased their RRR. If inflation keeps up, we might just see even more tightening moves in the coming months.

For the month of May, Chinese inflation is expected to show another jump and bring their annual CPI to 5.5%. If the actual figure exceeds the forecast, the PBoC might have no choice but to hike rates again really soon. Don’t say you haven’t been warned!

U.K. (Tuesday, 8:30 am GMT)

Did you know that inflation in the U.K. is so stubbornly high that their annual CPI is more than twice as much as the BOE’s target? Yep, that’s right. As of April this year, their annual inflation rate stood at 4.5% even though their central bank just wants to keep it at 2%. How much higher should it go before the BOE policymakers decide to hike interest rates?

U.K. annual CPI is estimated to hold steady at 4.5% in May, suggesting that inflationary pressures refuse to back down. However, this probably wouldn’t be enough to ruffle BOE Governor Mervyn King‘s feathers since he expects that inflationary pressures would subside during the second half of 2011.

A weaker than expected CPI reading will most likely confirm that the BOE interest rate would be nailed at 0.5% for the rest of the year, which might be bearish for the pound.

U.S. (Wednesday, 12:30 pm GMT)

Uncle Sam is also set to release its CPI figure this week and prove that Fed Chairman Ben Bernanke and his boys were right in claiming that the surge in price levels was temporary. Their monthly CPI logged a mere 0.4% uptick in April, a notch lower than the 0.5% increase seen last March. For May, headline CPI is expected to show a slightly slower 0.2% rise while core CPI is estimated to print another 0.2% increase.

Judging by the tone of Bernanke’s latest speech, it seems that the Fed head isn’t really bothered by inflation. After all, their annual inflation figure is still safely below their 2% central bank target.

Still, I wouldn’t count the U.S. CPI release as a non-event. Bear in mind that the Fed is getting frustrated with the slow pace of economic recovery in the U.S., which is why they’ll be sticking to their “exceptionally low” interest rates for an “extended period” of time. Bleak inflation figures could prolong this period even more and dampen demand for the Greenback.

Euro Zone (Thursday, 9:00 am GMT)

During their latest rate statement, the ECB once again expressed “strong vigilance” for persistent inflationary pressures. If you aren’t convinced that ECB President Jean-Claude Trichet and his men are set on fighting inflation, let me remind you that they surprised the markets with a 0.25% interest rate hike last April. Did you see how EUR/USD jumped by more than 150 pips then?

Those who saw that interest rate hike coming priced in their expectations as early as March when Trichet started emphasizing their commitment to price stability. At that time, EUR/USD was perched right on the 1.4000 handle, before it climbed steadily to the 1.4800 area on rate hike expectations.

This week’s euro zone inflation reports seems to suggest that Trichet and his buds still have a lot of work to do before they tame inflation. Their CPI is expected to show a 2.7% year-over-year increase in May while core price levels could print an annualized 1.6% rise. If the actual figures surpass these estimates, we might see the euro pairs fly up the charts. Hold on to your hats, fellas!

I’m pretty sure you can’t wait to catch some pips off these inflation reports but before you jump in any trades, I suggest you go over the two main ways to trade the news. And if you want to be in the loop during the release of the reports, make sure you follow us on Twitter and Facebook.