Inflation is a gradual rising in the overall cost of commodities and services. Certain goods may noticeably go up in price, while others may become cheaper, as well as some goods may not change in price at all. Inflation is assessed by the set of products, goods, and services that the average person or family regularly buys.
What types are there?
- Low – up to 6% per year;
- Moderate – 6 to 10% per year;
- High – 10 to 100% per year;
- Hyperinflation – prices go up by hundreds or thousands of percent.
How does an increase in prices affect the foreign exchange market and Forex brokers?
Inflation is the major economic indicator, which must be always considered by traders operating in the Forex market due to the fact that the level of this indicator has a significant impact on the monetary policy of central banks, including its foreign exchange component, which directly influences the rates of national currencies.
When inflation starts to grow substantially, central banks typically resort to an excessive increase in the refinancing rate. Naturally, this leads to a stronger exchange rate for the currencies emitted.
However, inflation devalues the currency, so in the long run, the currency of the country with a high level of increase in prices will tend to decline compared to the currency of the country with lower levels of it. Hence, the implications of inflation on exchange rates are ambiguous.
High inflation is prone to causing national currency depreciation. Though usually, the opposite is true: a weak currency drives an increase in prices. Nations that import significant amounts of goods and services have to pay more for such foreign supplies in other national currencies when their national currency decreases in relation to the currencies of their trading partners. Currency strengthening amid inflation may occur in a scenario when some countries’ monetary resources appear to be more attractive than others.
Inflation around the world
Inflation has been rising vigorously in most countries lately. Probably not a single category of goods has not gone up in 2022. The United States recorded the highest inflation rate in 40 years at 7.7% per year. On top of that, such a tendency has driven up interest rates around the world. It’s generally a chain response: when the U.S. boosts the rates, it usually leads to a rise in the price of the dollar. Hence, other central banks end up having to either raise rates or tolerate a weakening of the domestic currency.
In Turkey, inflation has reached an astounding 84%. A number of factors lead to it. Among them is the weak national currency, the lira. Its current exchange rate explains why Turkey imports goods at high domestic prices.
Argentina’s 88% excessive inflation may lead to a compelling devaluation of the nation’s currency. The Argentine peso exchange rate is exhibiting a record drop to 180 pesos per U.S. dollar.
Overall Inflation in Europe approximated 9% in December 2022. The situation in the UK is similar, with an increase in prices at 11.1%. The rate of price increases varies across Europe, with the fastest growth rates in the Baltic States.
Inflation is one of the forces that can trigger a currency cost to rise or fall. Simply put, when the prices go up, interest rates go up and the currency gains more market appeal. However, this is not a permanent trend.
The key thing to keep in mind is that inflation leads to a loss in the purchasing capacity of money.