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Inflation is one of the most important macroeconomic variables, since it reflects the rate at which the general prices of products and services in a country are increasing. Changes in inflation have a substantial impact not only on the economy and monetary policy of a country but also on the currency market. In this article we will provide practical examples of the use of inflation while in Forex trading.
Let's say you have $ 300 today and you want to spend it on the purchase of $ 100 worth of food, $ 100 on auto fuel and $ 100 on visiting the dentist. Imagine also, while you have been postponing these expenses, inflation increased by 10%. Now $ 330 will be needed to pay for the same number of products and services. You will have to earn an extra $ 30 or reduce your expenses by selecting cheaper groceries or postponing your visit to the dentist. The point is that inflation reduces our purchasing power, making more expensive the goods and services. The Consumer Price Index (CPI) is the most common variable for measuring the inflation rate by collecting prices (usually monthly) for the basket of goods and services and the examination of their weighted average.
Inflation and the Forex market
Governments point to inflation, determining its optimal level and conducting monetary policy (in particular, changing interest rates). Commonly, optimal inflation in a growing economy is considered to be within 2-2.5 percent. Regularly, the central banks issue a report in which they announce the current and specific rates. For investors, forecasted and real values are essential. If the real value is worse than the forecast, the national currency could depreciate, other things being equal.
To give an idea of why this happens, let us suppose that a person from the USA. UU wants to import a product from Japan. Given the fixed exchange rate for the USD / JPY currency pair, if inflation in Japan increases, its products will become more expensive and less attractive for the US importer. This person can change his mind, reducing the demand for Japanese products and, therefore, the JPY. As a result, the JPY is likely to depreciate against the USD.
Inflation and market reports
On June 22 of this year, the Canadian CPI came to light in May, showing that inflation remained at 2.2 percent against a forecast of 2.5 percent. As a result, in July, Canadian goods and services were less expensive than the predicted levels. Therefore, the difference between real and predicted inflation suggests that there is a greater demand for Canadian currency. This led to an immediate appreciation of the loonie.
Despite what the theory posits, the market does not always react in this way. For example, on August 17 of this year, the Canadian CPI for July came out at 3 percent against a forecast of 2.5 percent. It was the highest inflation rate since September 2011, driven by the increase in gasoline prices, air transport, and tourist trips. According to the theory, the Canadian dollar should have depreciated. In fact, the CAD appreciated after the announcement and also managed to maintain the appreciation until the close of the day.
This example clearly illustrates the fact that investors must consider many other factors to understand the movement of the market and the price chart.
Any reference to movements or historical price levels is informative and is based on external analysis and we do not guarantee that such movements or levels can happen again in the future
DISCLOSURE OF RISKS
Product difficult to understand, the CNMV has determined that it is not suitable for small investors, due to the complexity and high risk involved.
Source: IQOption blog (blog.iqoption.com)