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Inflation rate, an important market mover in forex

December 18, 2017

Among the most relevant macroeconomic data for forex traders, inflation must absolutely be included, or even better all the data on production price trends (PPI) and consumption (CPI).

Very often, these data are not responsible for the strong immediate volatility for the most directly affected exchange rates (unemployment is definitely more impactful in the short term), but they are a key factor in the monetary policy choices of central banks and consequently on the performance of a currency in a medium term perspective.

In the western world, inflation seems to have disappeared with central banks setting targets that are hard to reach and trying to fight deflation, which is falling prices for consumers.

The situation is different in emerging countries, where the control of inflation is fundamental to avoid social and economic crises, as the personal income of citizens is still quite low.

The consumer price index measures the price change of a basket of goods purchased on average by consumers.

The producer price index measures the change in the price of raw and semi-finished materials necessary for the production of the finished product.

An excessive variation of production prices is usually transmitted with an increase in consumer prices, an increase that takes the purchasing power of the consumer away causing a contraction of consumptions due to a lower amount of money in his possession.

This is why central banks are always very attentive to inflation and the forex market is interested in monetary policy choices.

A central bank that sets inflation targets will do everything to prevent these levels being exceeded. But if this happens, it is very likely that the first measure adopted by a central bank fighting inflation will be a rise in interest rates.

Forex traders know very well that this kind of decision positively impacts the currency of the country in which the rates have been raised. The reason for this is obviously to be found in the higher return offered by the investment tools of the reference currency.

The increase in rates and the simultaneous strengthening of the currency should slow down consumption with less pressure on prices that should go down again over the months.

The same currency fluctuations may be responsible for a change in the inflation rate.

If a currency weakens strongly, the country exports will grow due to the greater competitiveness of goods and services, but imported products will definitely cost more, increasing internal inflation. At that point, a central bank must cut interest rates by making investments in the reference currency cheaper and weaker.

Obviously, expectations always dominate the exchanges and the so-called “buy rumour sell news” proves to be correct in a liquid market open 24 hours a day as the forex is.

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