Inflation rate

    By
    Andrey Orlov
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    1590

    What is inflation?

    Inflation is the rate at which the overall price of goods and services within an economy increases over a certain period of time. It is a measure for the devaluation of the currency of a country. The opposite of inflation is also called deflation.

    What is the impact of inflation on an economy?

    As the price of goods and service increases within an economy, the national currency can purchase less and so the purchasing power of money is reduced.

    Inflation is generally caused by an imbalance between the growth of the money supply and the expansion of an economy. If the money supply expands faster than the economy, then generally this results in high levels of inflation.

    Inflation can also be caused by an imbalance between the supply and demand for goods; if there is a high demand for scarce products, their price rises and this can cause inflation.

    How is inflation measured?

    There are a number of ways to measure inflation within an economy. These generally come in the form of price indices. The Consumer Price Index (CPI) is a common way of measuring inflation and gives the rate of price change for a basket of goods and services.

    Forex traders monitor inflation because it is a significant factor for central banks when adjusting interest rates, which in turn affects the value of currencies.

    Learn more about the impact of inflation on currencies and forex trading:

    Economic indicators and their impact on currencies

    Getting the right balance

    An economy that grows too fast can experience high inflation, leading to the rapid devaluation of a currency and hence its purchasing power. However, an economy with low inflation or even deflation is likely to have stagnated.

    It is the job of the central bank, through monitoring inflation and adjusting interest rates accordingly, to strike a balance. Many experts in the western world estimate an acceptable level of inflation to be at around 2.5%, although there are many debates and opinions on the matter.

    Say, for example, the British CPI reveals high inflationary data. The Bank of England may then increase interest rates to discourage borrowing and limit the money supply. Anticipating this interest rate hike and the subsequent strengthening of the pound, investors may invest in the currency. The favourable interest rates offered by banks and other financial institutions make it more attractive.

    It is worth bearing in mind that the relationship between inflation and interest rates is not always straightforward. It can take some time for a change in interest rates to have an impact on inflation.