Inflation, Why it is Important for Traders?

Economical reports are considered to have notable effects on the financial markets with some clear ramifications for the Forex market. In this article, we will dive into Inflation. Which is in this current 2022 texture of macroeconomic condition is very important.

 

Why is it important?

It is essential information for a currency’s macroeconomic outlook. This economic indicator may also be used to predict how the market will perform in the future and to assess if a certain currency is over or undervalued.

Short-term traders also can benefit from using the volatility on inflation economic data release news trading. Especially when the actual number release is far from expected or way above the expected forecast.

 

Basic Inflation

At the most fundamental level, inflation is a widespread increase in prices across the economy. This is a well-known fact. After all, who among us hasn’t reminisced about bygone eras of low rentals and inexpensive lunches? And who hasn’t observed the creeping rise of costs on everything from milk to movie tickets? We will discuss the many forms of inflation.

How this is measured?

Using rate at which the overall level of prices for various goods and services in an economy rises over a period of time. Usually in MoM (Month-on-Month) and YoY (Year-on-Year). It will be shown in negative or positive percentages from the previous data.

 

 

What is the Economic Effect of Inflation?

• Money loses value since it no longer purchases as much as it once did; a country’s currency’s buying power deteriorates.
• Central banks aim to maintain mild inflation of up to 3% in order to stimulate economic growth, but inflation far over that level can result in severe conditions such as hyperinflation or stagflation.

How Central bank control inflation?

By controlling the money supply using these tools:

• +/- The Interest Rate —
• +/- Reserve Requirement
• OMO – Open Market Operation — Buying securities, bonds, etc.

 

Basic Conclusion

While consumers may despise rising prices, many economists feel that a modest level of inflation is beneficial to a country’s economy. Typically, central banks try to keep inflation between 2% and 3%. 1 Significant increases in inflation over this range might arouse worries of impending hyperinflation, a catastrophic scenario in which inflation spirals out of control.

 

Consumer Price Index (CPI)

Definition: The CPI is a consumer-level index that is intended to reflect the change in the price of a set market basket of goods and services that is indicative of the purchases of a typical urban consumer. CPI is one of the economy-wide indicators, which are the broadest measurements of productive activity and are used to track the performance of a whole economy.

The Core CPI

Calculated in the same way as the CPI, but excludes volatile goods such as energy and food that are susceptible to price shocks, resulting in a distortion in the CPI calculation.

Check-out our forex calendar here: Trading Cocktail Forex Calendar

 

Why is it matter?

It is often regarded as one of the most effective measures of an economy’s present condition of inflation. The rate of inflation, or the pace at which prices of goods and services fluctuate, is governed by the economy’s demand for money and the supply of money. To assess if the money supply is sufficient to satisfy the economy’s demands, we must know the inflation rate. Additionally, inflation data is required to assess a monetary policy’s success in promoting maximum economic growth.

• CPI is one of the leading indicators used by the Central Bank to determine future policies.
• Because of the USD status as a reserve currency, it is arguably the currency of reference. That is the reason why U.S. CPI has a significant effect as a forex price mover.

A higher than expected CPI reading should be taken as positive/bullish for the USD, while a lower than expected reading should be taken as negative/bearish for the USD.

Check also the correlation of inflation, employment, and Interest rate in our previous article:

Full Employment Increase The Pressure on The Fed to Raise Interest Rates

 

Because inflation data is in the driver’s seat, it will dictate the direction of the market. In normal times, macro data will only alter patterns when a game-changing fundamental component is present. 90% of the time, macro data just offers the ebb and flow for the broader macro trend that has been defined for quarters, and in some cases, years.

When inflation is this high (as it has been since last year), it is a game-changer not only because it initiates a cycle, which is a critical basic aspect, but also because it impacts the economy significantly when it is this high (or low).