Inflation and deflation are two fundamental forces in currency trading that central banks are always concerned about managing. Central banks aim to balance inflation so that it does not turn too high, resulting in hyperinflation, or too low, leading to deflation.
However, at first glance, the fear of deflation seems unreasonable as lower prices may seem like a good thing for consumers. But for an economy, it means there is less growth, which is a major concern. Therefore, central banks must maintain monetary policy as a balancing act.
Containing inflation in the Western world has largely been achieved, with inflation levels in industrialized countries near the 7.5 percent range during the period of 1973 through 1987. A decade later, in 1989, inflation levels ranged at a much lower level of 3 percent. Today, however, the financial collapse of 2008 has led to low inflation growth, which is a reversal of expectations in the trading world.
Central banks around the world monitor inflation and raise interest rates to try to slow it down. They often include in their statements accompanying interest rate decisions that they will be vigilant over potential risks of inflation, commonly known as being an inflation hawk. Whenever inflation is feared to be lingering in the economy, traders interpret this fear as raising the probability that interest rates will increase.
The expectation of inflation increasing tends to generate in the market the anticipation of higher rates, and therefore works to support the buying of a currency. That is also why strong retail prices tend to undermine bond prices. Bondholders fear increased rates because they reduce the attractiveness of the bonds they hold, and the market lowers the prices of the bonds in order to equalize the yield of the old bonds with the new interest rates.
Inflation is a challenge for central banks, as it is particularly difficult to track and even more challenging to contain once the forces that lead to it, such as monetary stimulus and low interest rates, are released. Even the best economists disagree on how to measure and detect inflation, and as a result, there are many data sets relating to inflation. Central banks all over the world are trying to get an accurate answer to the question of what true core inflation is.
The complexity of measuring inflation sets up the forex market for surprises when data comes along showing that inflation has not been contained. If central banks cannot be accurate in measuring inflation, it may be difficult for an individual trader. Therefore, surprises can be expected when governments release inflation data, and the difference between expected and actual numbers moves the markets.
The challenge of getting a true measure of inflation has also been a focus of activity in Great Britain. The Office of National Statistics is introducing a new inflation calculator that allows individuals to calculate their inflation measure. This confusion and debate over how to detect inflation in Great Britain underscores that the issue is an international one. However, many key measures of inflation are tracked, and checking central bank websites provides direct inflation data for forex traders.
Inflation and deflation are fundamental forces in currency trading, and central banks aim to balance inflation so that it does not turn too high, resulting in hyperinflation, nor too low, leading to deflation. While measuring inflation is complex and sets up the forex market for surprises, traders can check central bank websites for direct inflation data to track and anticipate changes in interest rates.
Why Tracking Expected Inflation is Crucial for Forex Traders
As a forex trader, keeping a close eye on inflation data is crucial. But what’s even more important than current inflation levels is tracking expected inflation. Lucky for us, the Federal Reserve Bank of Cleveland issues regular reports on expected inflation for the US.
According to their July 22, 2014 report, the public expected an average inflation rate of less than 2 percent over the next decade. This signals that low inflation or even deflation could be looming in the near future. As traders, we need to be aware of these trends and adjust our strategies accordingly to stay ahead of the game.
How to Track Inflation and Understand Its Impact on Forex Trading
Inflation is a crucial economic indicator that can impact forex trading in many ways. To measure inflation in the United States, the Federal Reserve Bank uses the Core Personal Consumption Expenditure Index (Core PCE Index), which excludes temporary components like food and energy prices. However, to gain a more accurate view of inflation, economists have developed a trimmed PCE Index. Both indices reveal that inflation in the US has been below 2 percent since late 2014, which is considered the ideal rate by most central banks.
Apart from the PCE Index, other measures such as the Producer Price Index (PPI) and Consumer Price Index (CPI) also track inflation in the US economy. However, the CPI does not account for housing prices and may underreport inflationary pressures. Traders can also track commodity indexes such as gold, oil, and the Commodity Research Bureau to get a better understanding of inflation trends.
Inflation rates and expectations are essential for forex traders to analyze as they can influence central bank decisions on interest rates. Any rate above 2 percent is considered a signal of excessive inflation, which may lead to central banks increasing interest rates. To track inflation rates globally, traders can visit websites like Global-Rates.com, which provides a comprehensive list of inflation rates from various countries.