The sustained rise in the general price level of goods and services, measured by indices such as CPI and PCE, and the primary driver of central bank interest rate policy.
Inflation is the single most closely watched fundamental variable in forex because of its direct impact on central bank rate decisions. When inflation exceeds a central bank's target (typically 2% for most G10 central banks), the bank raises interest rates to cool demand; higher rates attract capital inflows and tend to strengthen the currency. When inflation falls below target, the bank cuts rates, which typically weakens the currency.
The Consumer Price Index (CPI) is the most widely followed inflation measure. It surveys the price change of a fixed basket of goods and services purchased by a typical household. Core CPI (which excludes volatile food and energy components) is often considered more informative for monetary policy decisions because it strips out supply-side shocks that monetary policy cannot address. In the US, the Federal Reserve's preferred measure is the PCE (Personal Consumption Expenditures) deflator rather than CPI, though CPI releases still generate the most immediate market reaction.
Inflation expectations are as important as actual readings. If markets believe inflation will remain above target for an extended period, they price in additional rate hikes even before the central bank acts - this shifts the currency upward in anticipation. Conversely, if inflation is falling rapidly, rate cut expectations develop and the currency weakens in advance of any actual policy change.
For forex traders, the practical calendar events are: US CPI and Core CPI (monthly, usually the second week of the month); Eurozone Flash CPI estimate (end of the reference month); UK CPI (monthly, mid-month); and Japan CPI. Deviation from consensus - particularly in Core CPI - consistently produces the largest immediate price reactions and is closely followed by every active fundamental trader.