Understanding CPI: A Practical Guide on How This Indicator Affects Your Investments and Your Wallet

2022 was a turbulent economic year for many European families. Prices skyrocketed across almost all sectors: from grocery shopping to electricity bills. We all felt how our money loses value. Behind this reality lies a fundamental economic indicator: the Consumer Price Index (CPI), a metric that determines inflation and, with it, our investment decisions.

What is the CPI really?

The CPI is the thermometer of a country’s economy. It is an indicator that measures monthly how the prices of a representative set of 500 goods and services that households habitually purchase vary. In Spain, the National Institute of Statistics (INE) is responsible for calculating and publishing this figure.

At first glance, many confuse the CPI with inflation, but they are distinct yet related concepts. Inflation is the phenomenon of a widespread rise in prices throughout an economy, while the CPI is the statistical tool that allows for precise and comparable measurement of that inflation. In other words: the CPI is the instrument; inflation is the problem it measures.

The factors that move the CPI

Why does the CPI go up or down? The answer is complex because multiple economic variables intervene:

Production costs: When labor, materials, or energy become more expensive, final prices inevitably rise.

Aggregate demand: If everyone wants more housing, more food, or more services simultaneously, prices soar. This effect is especially evident in the real estate market.

Exchange rate: A weakened national currency makes importing goods from abroad more expensive, pushing the CPI upward.

Central bank policies: When interest rates rise, the economy cools and the CPI tends to decrease. The opposite occurs with low rates.

External shocks: Wars, pandemics, or natural disasters disrupt the supply of goods, creating shortages and price increases. The invasion of Ukraine in 2022 is the most recent example: it cut off European supplies of Russian gas, causing an energy crisis that drove the CPI up across the continent.

The drama of the CPI in 2022: data that make a difference

The numbers speak for themselves. In Spain, the CPI closed 2021 at 6.5%. By March 2022, it was already at 9.8%. The peak came in July with 10.8%, exactly coinciding with the highest geopolitical tension following the invasion of Ukraine.

What changed between June and December? The European Central Bank (ECB) began aggressively raising interest rates from summer onward. Although this measure, unpopular for indebted families and businesses, gradually curbed inflation.

Compared to other European countries in December 2022, the situation varied considerably: Italy reached 11.6%, Poland 16.6%, while France remained at 5.9%. The Harmonized Consumer Price Index (HICP) for the entire EU was at 5.4%, slightly lower than Spain’s.

What are the consequences of a high CPI for the economy?

A high CPI is not just a statistical number; it has real and tangible effects:

Loss of purchasing power: Your salary is worth less each month. What cost 100 euros a year ago now costs 110 or 115.

Effects on stock markets: 2022 was devastating for investors. The German DAX fell 12.5%, the EURO STOXX 50 lost 11.4%, the Spanish Ibex 35 plummeted 6.07%. Investors flee stocks when inflation is high because government bonds offer more attractive yields. Additionally, economic uncertainty generates extreme volatility.

International competitiveness: A country with a very high CPI sees its exports become more expensive, losing global competitiveness. Its companies become less attractive to international buyers.

Economic instability: Inflation breeds distrust. Companies hesitate to invest, families reduce consumption, and job creation is discouraged.

How is the CPI calculated: the INE methodology

The process is more sophisticated than it seems. The INE collects price information on 500 representative goods and services from various retail outlets each month. But not all weigh the same: it uses a weighting system where each product has a “weight” according to its importance in household spending.

For example, energy has a higher weight than sweets because families spend more on energy. This explains why when electricity prices rise, the CPI increases proportionally more.

The final result is broken down into thematic sub-indices: food CPI, housing CPI, transportation CPI, etc. The weighted combination of all these produces the overall CPI you see in the news.

IPCA: the CPI comparable at the European level

To compare inflation across EU countries, there is the IPCA (Harmonized Index of Consumer Prices). It is calculated using the same methodology in all member countries, allowing for precise comparisons. It is the metric used by the ECB to monitor inflation in the eurozone and make monetary policy decisions.

In June 2022, both the Spanish CPI and the IPCA were around 10%. Six months later, both had decreased significantly thanks to the ECB’s rate hikes.

Forecasts for 2023: where is the CPI heading?

Analysts foresee a sustained downward trend throughout 2023. Bankinter estimated that the Spanish CPI would be around 4% by year-end. The higher interest rates from the ECB should continue to control inflation, although the process will be gradual.

Investment strategies in times of high CPI

How to protect your savings when the CPI is soaring? Several approaches depend on your risk profile:

Asset diversification: Don’t concentrate everything in stocks. Combine stocks, bonds, commodities, and real estate. Risk is spread out, and returns stabilize.

Real assets: Investments in real estate, gold, oil, or other commodities generally maintain their value during inflation. When prices rise, these assets tend to appreciate as well.

Inflation-linked bonds: Some government bonds adjust their yields according to the CPI. They are especially useful in inflationary scenarios.

Short-term government bonds: Offer safety and, with high interest rates, more attractive yields than years ago. Ideal for conservative investors.

Defensive sector stocks: Companies in basic services, water, renewable energy. These sectors maintain demand even in crises.

International investment: Diversifying into foreign currencies and markets reduces the impact of high local inflation.

The banking sector: winner of inflation (with caveats)

When interest rates rise, banks expand their profit margins: they lend at higher rates and pay less for deposits. Their profits tend to grow, making their stocks attractive to investors.

However, there is a dark side: if inflation persists, families and businesses struggle to pay their debts. Defaults multiply, eroding bank profits. Additionally, in uncertain contexts, many people may hesitate to take out new loans.

Final recommendations: investing wisely in turbulent times

High inflation is not a reason to halt your investment strategy. Markets are cyclical, and corrections offer opportunities. The key is:

1. Diversify your portfolio across different assets and regions
2. Invest in solid companies with proven track records, especially in essential sectors
3. Don’t neglect fixed income: short-term government bonds offer attractive real yields
4. Avoid excessive leverage: in volatile times, debt amplifies losses
5. Never invest more than you can afford to lose: it’s the golden rule

The CPI is an indicator everyone should understand. It directly affects your purchasing power and the decisions you make about where to invest your money. In 2023, with the CPI declining after ECB measures, the outlook is clearer than in 2022, but constant vigilance remains essential.