Data source: MacroMicro
High inflation has become a major threat to the global economic outlook, coupled with the ongoing war between Russia and Ukraine. Prices continue to spiral out of control. When will the unstoppable inflation and interest rate hike storm leave?
What is inflation?
Inflation is defined as "a sustained and considerable increase in the general price level over a period of time" or "a persistent decline in the purchasing power of the equivalent currency". Therefore, an economy is said to be experiencing inflation only if its general prices are characterized by "widespread", "persistent", and "significant" increases.
What does inflation have to do with raising interest rates?
When prices rise and the inflation rate rises, if interest rates do not rise in tandem, the inflation rate will be higher than the bank deposit rate, and the central bank will raise interest rates in order to avoid such a situation.
Common indicators of inflation
Consumer Price Index (CPI), an indicator of price changes of products and services related to people's lives, is one of the main indicators of inflation and deflation.
Generally speaking, when the economy is overheated and the CPI is growing too fast, the State will control it by means of interest rate hikes and benchmark cuts, so as to reduce the amount of capital in the market. When market capital becomes scarce, enterprises and the public will consume less, and corporate profits will drop. At this time, people generally do not expect inflation to rise sharply, that is, they will expect economic growth to slow down, and this expectation will be reflected in the stock market, and stock prices will generally fall.
This explains why the market evaporated one day after the US Department of Labor released the CPI on April 12, as the market expected that the Fed might take steps to control inflation, in other words, the market reflected the possibility of a slowdown in the economy.
What is included in the CPI?
In the U.S., for example, "products and services items" on the CPI include: food, energy, commodities, housing, health care, transportation, clothing, education, etc., while investment items such as stocks, bonds, life insurance, etc. are not included.
CPI Release Date
Published once a month
Impact on Currency and Stock Market
The CPI is an economic outcome and phenomenon that does not directly affect the stock market, but the CPI affects policy making, and policy affects the stock market.
Generally speaking, an increase in the CPI represents an increase in the rate of inflation, which means that there are signs of rising prices and inflation, and the central bank will adopt monetary tightening policies, such as raising interest rates, which will make it easier for capital to flow out of the stock market, resulting in a drop in stock prices.
When the CPI falls, which represents deflation, or when there are signs that prices and inflation rates are falling, the central bank may adopt a policy of monetary easing, which makes it easier for hot money to flow into the stock market, leading to a cycle of rising stock prices.
Currency and stock markets reflect the market's expectation of future economic growth, and economic growth is related to inflation. When people generally expect that there will be inflation in the future, it means that the purchasing power in the future will definitely be lower than the current purchasing power, which in effect encourages people to spend and invest, thus promoting economic development, and the financial market will also be very prosperous at this time.
However, the recent CPI results have created huge volatility in the market, suggesting that inflation is still rising, the US dollar will strengthen and other currency pairs (including cryptocurrencies and commodities) will come under pressure. This will push investors back into an insurance mode and reduce investments in financial products such as cryptocurrencies and equities.
Why do most economists think that a moderate rise in inflation is good?
A mildly rising inflation rate (e.g., inflation rate between 1%~3% or an average of about 2%) is conducive to economic growth and price stability.
For example, if inflation rises moderately, enterprises are more likely to make profits and will be more willing to invest and hire more employees, which will help productivity gains, job creation and sustainable growth, and lead to a virtuous cycle; on the other hand, if deflation persists with falling prices and manufacturers' inventories increase due to the fear of delayed spending, enterprises will be reluctant to invest, and they may even cut wages and lay off employees, and economic growth will shrink. Economic growth will then shrink.
A decline in the purchasing power of money simply means that the same amount of money cannot buy the same amount of goods after inflation because of rising prices. In other words, the rate of decline in purchasing power can be quantified by observing the increase in the average price of a basket of products and services (e.g. food, transportation) over a certain period of time. The CPI is used to calculate the change in the prices that consumers pay for goods and services over a certain period of time.
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