If the CPI number rises, it means that the average household or consumer has less money for discretionary spending.
Longer term, it means that wages will come under pressure as employees find that they are living on less, and will then either request higher pays, or look for employment opportunities elsewhere.
The vicious circle
Employers too, will find that the costs of running their business will go up. Higher operating costs, mean lower profit margins and lower margins mean that they will have less capacity to meet the higher wage demands employees are now requiring.
Higher costs equal lower profits, and that means lower share prices. To avoid posting lower profits, businesses must then consider passing these higher costs to their customers, which of course will trickle down to CPI numbers. Potentially a cycle could occur where higher prices cause higher costs and higher prices again.
So we can see why world central banks keep such a close eye on the rate of inflation.
Winners and losers
Some businesses may benefit from a CPI rise. They can use this as justification for putting up prices either by more than the CPI or pass on price rises that have not been affected by CPI, thus increasing their profit margins.
For example, a services industry may pass on a 5% price rise, whereas the cost of running their business may have only increased by 1-2%.
It is also important to note that even if the overall number does increase it may be that several of the 11 categories have actually fallen, but that the rises in the other sectors has been sufficient to cause an overall rise. A rise in alcohol and tobacco and healthcare is not going to have any affect on an individual, non-smoking, teetotaler with good health.
What does a higher CPI figure mean to my stocks?
The impact of CPI figures will vary from stock to stock and, probably more importantly, industry to industry. A services industry might have little exposure to CPI based values, whereas a manufacturer is likely to be more exposed, and therefore their profitability and share price can be influenced by a change in these figures.
It is often the unexpected numbers that have the biggest influence on the market. If the market expects a 1% rise and the actual figure turns out to be, say, 3% this is more likely to have an adverse affect. Most economic data has already been factored in before its release, but anything that greatly varies from that expectation is going to have a greater impact.
So we can see that it's not just the figure or percentage, but rather the variation away from the expectation that will cause a share price to rise or fall.
To summarise, the market does not like unexpectedly high rates of inflation as this causes uncertainty to companies profit outlooks. The inflation however will affect each industry in different ways.
How is it calculated?
CPI by definition is the measurement of the price change in a basket of consumer goods. The actual goods within this basket are divided into 11 categories:
alcohol and tobacco
clothing and footwear
housing
household furnishings
supplies and services
health
transportation
communication
recreation
education and
miscellaneous
CPI is simply the measurement of change in the overall cost of these items. If the original basket had a value of 100 and this quarter's costs have risen to 102 we'll see a CPI rise of 2%. The increase in CPI is called inflation. Very simple
By: www.fingala.com
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