Few economic data releases move the Australian dollar as reliably as the Consumer Price Index. Every quarter, when the ABS publishes its inflation figures, currency traders around the world pause to digest the numbers. The reason is straightforward: inflation data shapes expectations about interest rates, and interest rates are the single most important driver of currency values. But reading the CPI properly for FX clues requires looking beyond the headline number.

Why Inflation Matters for Currencies

Central banks set interest rates primarily to manage inflation. When inflation is running above the target band — two to three per cent in Australia’s case — the RBA is more likely to raise rates or keep them elevated. Higher rates attract foreign capital seeking better returns, pushing the AUD higher. When inflation is falling toward or below target, the RBA has room to cut rates, which tends to weaken the dollar.

This relationship means that every CPI release is effectively a referendum on future RBA policy. A hotter-than-expected inflation print narrows the window for rate cuts, supporting the AUD. A softer reading opens the door to easing, weighing on the currency. The market reaction can be swift — the AUD can move a full cent against the US dollar within minutes of a significant CPI surprise.

Headline Versus Underlying Measures

The headline CPI figure captures the total change in consumer prices. But the RBA pays closest attention to underlying measures — specifically the trimmed mean and weighted median. These strip out the most volatile price movements to reveal the underlying inflation trend.

For currency traders, this distinction is critical. A headline CPI print that looks high but is driven by a one-off spike in fuel prices or a seasonal jump in fruit and vegetable costs will be viewed differently from one where underlying measures are also elevated. The RBA has been explicit that it watches the trimmed mean most closely, so that is where FX market attention is concentrated.

In recent quarters, there have been instances where the headline CPI and trimmed mean have told quite different stories. A sharp fall in petrol prices might pull the headline down while services inflation keeps the trimmed mean stubbornly high. Understanding which measure is driving the narrative at any given time is essential for interpreting the AUD’s reaction.

The Services Versus Goods Split

One of the more informative ways to break down the CPI is the split between goods and services inflation. Goods inflation — covering physical items like food, clothing, and electronics — has moderated significantly from its post-pandemic peaks as supply chains normalised and demand shifted.

Services inflation has been stickier. Rents, insurance, healthcare, and education costs have remained elevated, reflecting tight labour market conditions and structural factors. For the AUD, persistent services inflation is more concerning because it suggests that domestically generated price pressures are not easing, which limits the RBA’s ability to cut rates.

Data analysts, including AI consultants in Sydney working with financial institutions, have increasingly applied machine learning models to disaggregated CPI data to identify leading indicators within the inflation basket. Which components tend to move first, and which lag? These patterns can offer early signals about where the trimmed mean is heading before the official data confirms it.

Market Positioning Ahead of CPI

Currency markets do not simply react to CPI data — they position ahead of it. In the days before each quarterly release, economists publish forecasts, and the AUD often begins to move based on the consensus expectation. If the market expects a benign reading, the AUD may soften in anticipation of future rate cuts. If the consensus points to persistent inflation, the dollar may firm.

This means the actual market reaction depends heavily on the surprise element. An inflation reading exactly in line with consensus might produce little movement, even if the absolute number is high. A small miss in either direction can generate an outsized reaction if the market was heavily positioned one way.

Reading CPI in Context

No single data point should be read in isolation. The CPI’s impact on the AUD depends on what else is happening in the economy and in global markets. A hot inflation reading during a global risk-off episode might not support the AUD as much as it would in calm markets. A soft CPI when commodity prices are surging might be offset by positive terms-of-trade effects. Tracking related indicators — wage growth, employment data, business confidence — provides context for interpreting whether a given CPI reading is a one-off or part of a trend.

The CPI is ultimately backward-looking. The AUD, by contrast, is priced on expectations about the future. The connection runs through the RBA’s reaction function — the rules that govern how the central bank responds to data. When the RBA signals it is prioritising inflation control, every CPI print becomes more consequential for the dollar. When the board hints at greater tolerance for above-target inflation, the CPI’s currency impact diminishes.

For Australians watching the dollar, the quarterly CPI release is essential viewing. But knowing how to read it properly makes the difference between informed analysis and noise.

James Hargreaves is a Sydney-based financial journalist covering currency markets and macroeconomic trends.